Question

using an example define a negative externality and explain hiw it can create a market failure.

Answer 1

Negative externality means that there is a negative consequence of a production or action which is not the intended effect of the production/action. One example would be CO2 emission by a factory, the firm is not paying for the emission but it increases the level of CO2 in the air and which in turn may create hotter weather and climate change. In this case, a market failure occurs as the pollution is not internalized i.e. pollution is not included in the private marginal cost. So, it will lead to a market failure as more of the quantity will be produced than socially optimal quantity.