Question

How are markets intended to work , and how do externalities stop markets from working?

Answer 1

Answer - Markets represent the interaction of the buyer and seller in a common place. It is a place or the mechanism that facilitates the exchange of the goods and services. The price and quantity in a free market is determined by the forces of demand and supply. The price and quantity are determined at the level where the demand and supply are equal to each other.

The externalities reduce the socially optimal level of output. These increase cost to the society and reduce the output resulting in the higher prices and incidence of externalities such as the pollution. Hence , the presence of the externalities causes the marker failure if these are not regulated by the government