Market failures: Externalities When a market outcome affects parties other than the buyers and sellers in the market Side-effects are created called externalities o Externalities cause markets to be inefficient and thus fail to maximize total surplus o when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect, an externality arisesMarket Failures: Externalities • When a market outcome affects parties other than the buyers and sellers in the market, side-effects are created called externalities. • Externalities cause markets to be inefficient, and thus fail to maximize total surplus. • when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect, an externality arises