Externalities
Externalities are the uncompensated side effects of production or consumption that affect third parties. Negative externalities impose costs (pollution, noise); positive externalities provide benefits (education spillovers, research). Externalities cause market failure because prices do not reflect all costs and benefits.
Real World
Residents near Heathrow Airport suffer noise pollution and lower house values from flights they do not take, bearing external costs imposed by airlines and passengers who do not compensate them.
Exam Focus
Draw a diagram showing the divergence between private and social costs or benefits; label the welfare loss triangle to secure full diagram marks.
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