Externality is a situation in which the activity of one entity affects the welfare of another entity in a way that is outside the existing market (Rosen, 2005, p. 47). Simply put, externalities are the costs or benefits that arise from market transactions which are not reflected in prices. And when we speak of negative externalities, obviously, these are costs to third parties (other than the producer and consumer). Why is there negative externality? I learnt from Economics that under a competitive system, the market price of a good takes into account both the negative and positive effects of using the good. However, ...
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