How is the existence of external costs causing market failures?

Question

Thoughts anyone?

Answer 1

Bascially, the existence of external costs causes market failures because the costs are not properly factored in to the market plan.

Answer 2

External costs can be described as the negative effects imposed indirectly on a third party due to the production or the consumption of certain goods by other parties.

Example; smoking, while giving certain amount of satisfaction to the smoker, causes other people (non smokers) around him to indirectly inhale the secondary smoke coming out of his mouth. That third party may, due to that harmful smoke, need to see a doctor for related illnesses.

These costs of seeing a doctor, loss of productivity due to medical leave, inconvenience, etc is the external costs of smoking, assuming they can be put in terms of dollars and cents

In a perfectly competitive market, the price mechanism should include all these other costs in deriving the market supply curve of cigarette. Unfortunately, it doesn't. Hence there is inefficiency in the allocation of the economy's resources in the production of that product.

Answer 3

kool is correct. freeloading is also an external cost and often the justification for government provided public goods such as transit.