Question

Why are spillovers (negative ones) an example of market failure?

Answer 1

Spillover effects refer to effects of some other events in a seemingly unrelated context. So they refer to negative impact of other events in a different context.

For instance the economy of one Nation may impact the economy of another Nation as a spillover effect. There may also be spillover effect such as pollution in the environment because of the functioning of a polluting factory. In such cases a market failure occurs because the market is unable to allocate efficient resources for itself.

In a negative spillover effect such as impact on the domestic economy due to a slowdown in another economy there will be a market failure in the domestic economy because the country is not able to efficiently allocate its goods and services.