Question

Why are externalities a problem in a market system

Answer 1

Externalities are a problem because most externalities are negative. Pollution, for example, is a well-known negative externality. A corporation may decide to cut costs and increase profits by implementing new operations that are more harmful for the environment. The corporation realizes costs in the form of expanding its operations but also generate returns that are higher than the costs. However, the externality also increases the aggregate cost to the economy and society, making it a negative externality. Externalities are negative when the social costs outweigh the private costs.