How do you explain how do externalities affect the economy?

Answer 1

Externalities are costs or benefits incurred by third parties not directly involved in an economic transaction, affecting overall economic efficiency. Positive externalities, like education, can lead to societal benefits such as a more skilled workforce, while negative externalities, like pollution, impose costs on public health and the environment. These effects can distort market prices and lead to overproduction or underproduction of goods, ultimately impacting resource allocation and economic welfare. Addressing externalities often requires government intervention, such as regulation or taxation, to align private incentives with social welfare.