What is an externality in the context of market failures?

An externality is a situation where a person's or a company's actions affect others who are not directly involved in the activity, leading to market failures. This can happen when the costs or benefits of a decision are not fully reflected in the prices, causing an imbalance. For example, if a factory pollutes the air while producing goods, the nearby residents suffer from poor air quality, but the factory does not pay for this damage. This means the factory's production is cheaper than it should be, leading to overproduction and harming the community. Therefore, externalities show that sometimes the market does not work perfectly because it doesn't take into account all the effects of economic activities on people and the environment.