What is the primary effect of externalities on market outcomes, leading to deadweight loss?

Externalities occur when the actions of one party affect another party who did not choose to be involved in that action. For example, if a factory pollutes the air, nearby residents suffer health issues without any compensation. This leads to a situation where the factory produces more goods than is socially optimal, as it does not consider the negative impact of pollution. As a result, the market price does not reflect the true cost of production, causing overproduction and ultimately creating deadweight loss, where resources are not used efficiently. In simple terms, externalities disrupt the balance of supply and demand, leading to a loss of economic efficiency.