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Externalities

Externalities are a common form of market failure. Peter Smith brings together the key definitions needed to analyse this important topic in economic analysis, and provides the relevant diagrams

An externality arises in a market when there are costs or benefits that are external to a market transaction, in the sense that they are incurred (or enjoyed) by a third party. This means that they are not reflected in market prices. This leads to a misallocation of resources in society.

• The preferred allocation of resources within a market occurs when marginal social cost (MSC) is equal to marginal social benefit (MSB).

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Previous

The International Monetary Fund: what is its real purpose?

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UK competition policy: a new era

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