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4. Explain why market failure occurs when an externality has resulted from an exchange between two parties. In your response, define the term externality and discuss at least one mechanism to correct the market failure. (250 words)
Externalities can be defined as third party effects arising from the production and/or consumption of goods and services for which no appropriate compensation is paid. Market failure can result from an externality that occurs from an exchange by having a byproduct which is not accounted within the price of the good exchange.d When there is no price mechanism to compensate and fully account for the social cost and social benefits of production and consumption. When a company wants to maximize their profit they are only worrie d about their private costs and private benefits and do not worry about the general costs associated with their product. Therefore they ignore the costs of for instance a chemical spill that might hurt the environment as well as destroy the ability of other industries to function. This is when market failure occurs because there are no mechanisms to balance private optimum output with social optimum output. One of the principle mechanisms for correcting externatliies and

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