What is one consequence of externalities?

The presence of externalities leads to market inefficiency because they represent costs or benefits that affect third parties who are not directly involved in the economic transaction. For instance, when a firm produces a product that generates pollution, the negative effects of that pollution on the surrounding community are not reflected in the cost of production. As a result, the market equilibrium does not account for the full social costs or benefits, leading to overproduction of goods with negative externalities or underproduction of goods with positive externalities. This misalignment between private costs/benefits and social costs/benefits can result in a loss of economic efficiency, where resources are not allocated in a way that maximizes overall welfare in society.

In contrast, perfect market equilibrium assumes that all costs and benefits are internalized within the market, which does not hold true in the presence of externalities. Higher production costs and increased pricing power for producers are also not direct consequences of externalities in the context of market inefficiency. Instead, these factors might arise independently of the externalities present.