Externalities — practice question

Since Adam Smith, most economists have treated competitive markets as the chief way economic activity is organised. They maintain that the interplay between producers and consumers can generate both allocative efficiency and productive efficiency. That said, it is debatable whether the market always delivers the optimum result on its own. In some cases there are strong reasons for the government to step into a market so that a better outcome is achieved than would arise from market forces alone. These are known as market failures. When firms make goods and services they look at the private costs they incur and the private benefits they obtain. For instance, a steel producer takes into account the price of iron ore, fuel, labour and administration, and then compares these costs with the revenue gained from selling steel. Yet people living close to the steelworks experience the effects of noise, dirt and polluted air created during production. Likewise, in many regions extracting iron ore may damage the environment, for example by degrading groundwater used for domestic consumption and reducing the range of wildlife and flowers. However, the competitive markets described by economists may not actually be present. Firms may join together to secure economies of scale, to pursue market domination, or to raise their market share. This sort of integration can result in a monopoly market structure. Many people think a monopoly always works against consumers because it is inefficient. Consequently, governments often place limits on monopoly activity.