External effects | Market failure

External effects are counted as one of all market failures. External effects are costs and damages to persons not participating in the market for a good, third persons.

External effects exists because the market does not take all the costs of the production and sale of a product into account. External effects can be both positive and negative. Negative externalities lead to a production of a product that is higher than what is socially desirable. Positive externalities lead to a production of a product that is lower than what is socially desirable.

The state can make use of price controls, prohibition, quantity regulations, taxes and subsidies to deal with externalities. Example of an negative external effect is pollution.