Positive externalities have a significant impact on consumer and producer surplus in a market. Consumer surplus is the difference between what consumers are willing to pay for a good or service and what they actually pay. Producer surplus is the difference between what producers are willing to accept for a good or service and the price they actually receive. In the presence of a positive externality, the social value of a good or service exceeds the private value. This means that the benefits to society, including non-paying third parties, are greater than the sum of individual consumer and producer surpluses. However, because these additional benefits are not reflected in the market price, the good or service is underproduced from a societal perspective. Consequently, both consumer and producer surpluses are lower than they would be if the positive externality were internalised. For instance, in the case of education, the private benefits (like increased earnings) are reflected in the market, but the broader societal benefits (like reduced crime rates and enhanced civic engagement) are not, leading to underinvestment in education. Government intervention, such as subsidies, can help align the market outcome with the socially optimal outcome by increasing both consumer and producer surpluses to levels that reflect the true social value of the good or service.

Yes, externalities can and do exist in perfectly competitive markets. The defining feature of a perfectly competitive market is that no individual buyer or seller has the power to influence the market price. However, this market structure does not inherently account for the external effects of production or consumption. For instance, in a perfectly competitive market for agriculture, farmers might use pesticides that seep into nearby water sources, creating a negative externality. Similarly, a company in a competitive market might innovate a new technology, creating a positive externality if that technology benefits other industries or the public. The existence of externalities in such markets leads to a divergence between private and social costs or benefits, resulting in a socially suboptimal level of production or consumption. This discrepancy highlights the necessity for government intervention, such as taxes, subsidies, or regulations, to correct the market outcome and ensure that the social costs or benefits are adequately reflected in the market.

The Coase Theorem, named after economist Ronald Coase, is a fundamental concept in environmental economics and the study of externalities. It states that if property rights are well-defined and transaction costs are negligible, externalities will be efficiently resolved through private bargaining, regardless of the initial allocation of rights. The theorem suggests that when parties can negotiate without cost and legal impediments, they can arrive at mutually beneficial agreements that internalise the externality. For example, if a factory emits pollution affecting nearby residents, under the Coase Theorem, the factory and residents can negotiate a solution that maximises total welfare, such as the factory reducing emissions in exchange for a payment. This outcome will be efficient regardless of whether the residents have the right to clean air or the factory has the right to pollute. The Coase Theorem highlights the potential for private solutions to externalities, but it also underscores the importance of clearly defined property rights and low transaction costs. In many real-world scenarios, high transaction costs and poorly defined rights prevent such private bargaining, necessitating government intervention to address externalities.

Private costs are the costs incurred by the individual or firm involved in a production or consumption activity. These costs are internal to the economic decision and are reflected in market transactions. For example, the cost of raw materials, labor, and utilities for a factory are private costs. In contrast, social costs encompass both private costs and external costs – the latter being costs borne by third parties not directly involved in the transaction. External costs are not reflected in the market price of goods or services. An illustrative example is pollution: a factory may emit pollutants during production, causing health issues and environmental damage. While the factory incurs its private costs, the broader society bears the additional costs of pollution, like healthcare costs and environmental cleanup. These external costs, when added to the private costs, constitute the social cost. The divergence between private and social costs due to externalities is a primary cause of market inefficiency and failure, necessitating government intervention to correct the market outcome.

Externalities are a central factor in the market failure associated with public goods. Public goods, by nature, are non-excludable and non-rivalrous, meaning they are accessible to all and one person's consumption does not diminish another's. However, when it comes to providing public goods, the market often fails because of the free-rider problem, where individuals benefit from a good without contributing to its cost. Positive externalities exacerbate this issue as the benefits of public goods extend beyond the direct consumers to society at large. For instance, a public park provides recreational space for the community, but its maintenance costs are not covered by the users directly. This leads to underproduction or under-maintenance of such goods, as private firms find no profit in providing them, and individuals are not incentivised to pay voluntarily. Hence, externalities play a pivotal role in explaining why markets often fail to provide public goods at an optimal level, necessitating government intervention for their provision and maintenance.