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An externality is a result of market failure. The impact of an externality creates costs or benefits not reflected in the competitive market price. For example, the price that Laura agrees to pay for George's house (my neighbor who likes to play loud, out of tune, guitar solos late at night) does not include the benefit that I receive from no longer having George as my neighbor. Externalities are commonly referred to as "spillover" or "third-party" effects that impact parties beyond those considered in the decision making process of individuals or by the transactions between parties. It is important to recognize that externalities can have a positive or a negative impact; economists typically classify externalities in this way.

Dealing with Externalities


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