An externality is the cost or benefit from production or consumption that affects others who did not originally buy or sell the product that is being produced or consumed (McConnell, Brue, & Flynn, 2015). An example of a positive externality would be immunizations like the flu shot. The flu shot helps prevent the spread of the flu to the general public. An example of a negative externality is a power plant that burns coal to generate electricity. The more demand from customerâs causes the plant to burn more which increases the level of pollutants.

Positive externalities could lead to inefficiency in the market economy when there is a difference between private and social gains. When there is a shortage of the flu shot leads to inefficiency in the market. The power plant that burns coal to generate electricity does not consider the indirect cost to those harmed by the pollutants which leads to inefficiencies in the market economy. When the market outcome is underproduction of goods or services that deals with positive externalities and when the market outcome is overproduction of goods or service that deals with negative externalities.

One way to help reduce market distortions of externalities is to have regulations. For example, the EPA (Environmental Protection Agency) has regulations around emissions for coal power plants like the Coal Combustion Residuals regulation (EPA, 2017). Another way to help reduce market distortions of externalities is to offer tax breaks.

Government policies usually focus on the larger social impacts like pollution. By focusing on the bigger issues, this will help more individuals and help reduce inefficiency.

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