all right so let's get to defining externalities and market failures so an externality what is it it's basically the cost or benefit of a market activity that affects a third party what do we mean by that we basically mean that a third party is someone that's not involved in the market transaction basically so a common example is cigarette smoke secondhand cigarette smoke right maybe you're at a restaurant you're sitting outside and someone is smoking a cigarette and for most people even if your smoker secondhand cigarette smoke isn't a very pleasurable odor okay so that would be a external cost right because you're not the one smoking cigarette but nevertheless you're you're being affected by it negatively another example that's a little more silly and light-hearted but it's a real a real-world example is when your neighbor is cooking some really good smelling food right you you you smell they're their home cooking it's you know just smells delicious it's kind of making you hungry that's a positive externality right because you you are in no way involved in the market transaction of buying the food or cooking the food or making the food or eating the food but nevertheless you actually get some benefits from just smelling it because it smells good right so that's that's what externalities are and that's what we mean by imposing costs or benefits on third parties it's it's the third party is someone that's not involved in the market transaction okay now as it turns out when there are externalities this leads to market failures and this is basically anytime there's an inefficient allocation of resources in a market so we've already seen plenty of examples of of market failures right with excise taxes with price controls with types of firms that aren't perfectly competitive so monopoly oligopoly monopolistic competition we've seen a lot of examples already of market failures and so it's basically anytime there's deadweight loss or any or any loss of efficiency basically but almost always involves some deadweight loss so that's a market failure and so there you go externalities are one type and I just listed a whole bunch of other types that we've already seen okay so when we're thinking about these externalities we basically want to break break down the costs and/or benefits into some sub categories okay so we've got we can break it these costs we're gonna mostly think about externalities it's costing society but they also can sometimes be beneficial externalities but pollution for example is a negative externality so let's think of it in those terms right pollutions so with pollution there are internal costs of the pollution but there are also external costs of the pollution thus externalities and then we can talk about the social cost which is basically these two things internal and external costs added together okay so what are internal costs the costs of market activity paid only by the participant right the person or firm creating the pollution okay so this is like not the third party cost this is the the normal cost that we think of it's internal to the firm it's internal to the the market activity whereas external costs these are any costs that are imposed on people that aren't participating in the market okay so the cigarette secondhand smoke for example and then like I said the social cost is both of these things added together when we consider both of these costs that gives us the total cost to society so the social cost