Externalities Occur when one does not consider certain actions taken while it
affects the other without his involvement. Any type of pollution is considered
as a market failure in the attempt to achieve social optimum level. To be more
clear about this lets take an example of a steel firm, which decides to dump
its waste in the river close by, doesn’t realize that it’s affecting the
fisherman’s daily catch. The more the firm dumps the fewer there are fishes in
the lake. The decision doesn’t affect the firm in any way and it does not have
any external cost. Since there are no market prices reflected the firm doesn’t
know how much they are producing. It can be either too much or too less. This
can compel the industry to pay a social cost. The following graph will show a
clear picture of negative externality.