1. Market Failure
Market prices usually reflect the benefits and costs received by the producers and consumers involved in an exchange.
A kind of market failure occurs when market prices DO NOT reflect all the costs and all the benefits involved.
This type of market failure is called an externality.

2. Externalities
Externalities exist when some of the costs or benefits associated with the production or consumption of a product "spill over" to third parties, who do not produce or pay to consume the product.
Negative externalities are costs paid by someone who does not produce or pay to consume a product.
Examples?
Cigarette smoking: secondhand smoke; health costs

3. Externalities
Positive externalities are benefits enjoyed by someone who does not produce or pay to consume a product.
Examples?
Education: society benefits from increased productivity; less crime; lower rates of poverty; etc.

4. Positive or Negative Externalities
Driving a car on crowded highway?
Negative: exhaust fumes, etc.
Apartment dwellers who buy fire alarms or fire extinguishers?
Positive: other dwellers benefit
Neighbor playing loud music while you study?
Negative: you bear cost of not concentrating
New landscaping in neighbor’s yard?
Positive: increases value of houses in neighborhood.

5. Activity 12.2: Externalities Worksheet
Price S P1 P D
Quantity (Tons of Steel) Q1 Q

6. Activity 12.2: Externalities WorksheetP
Price
Quantity (Years of Education) S D Q P1 Q1 D1