When a market fails to account for externalities, the result is that the level of output is often not at the __________ level, leading to inefficiencies in social welfare.

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Seekh · Accepted Answer

When a market ignores externalities, it produces too much or too little of a good compared with what is best for society. Because the private cost or benefit does not include the spillover effects, the market price does not reflect the true marginal cost or benefit to everyone. Thus the quantity produced is not at the socially optimal level, where the marginal social benefit equals the marginal social cost. This mismatch creates inefficiencies that lower overall social welfare, as seen when a factory emits pollution that hurts nearby residents but the firm does not pay for it. For example, a factory that releases smoke will produce more units than the socially optimal quantity, because the cost of the pollution is not counted in its price.

When a market fails to account for externalities, the result is that the level of output is often not at the __________ level, leading to inefficiencies in social welfare.

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Deep Dive: Externalities and Social Optimum

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