Does the existence of externalities indicate a market failure?

1 Answer
Dec 24, 2015

Yes, either for positive or negative accounting.


An externality consists in non-accounted costs (or savings) which are generated by one activity in a form other than its core objective - e.g. pollution by a company; peers protection from a disease by a vaccinated individual.

If the externality's cost is not included in the private costs that the supplier incur, then it is a market failure, because someone else is paying - not necessarily in money, directly - for that effect. For example, pollution might drive up the cases of pollution-related illnesses.