Externalities are market failures because both positive and negative bring a negative outcome at some point. The market system discourages externalities because it leads to misallocation of funds and is cost inefficient. For example, when a company spills oil in a river it does not consider the fact that the people around will have to start buying water since they cannot consume the already polluted water.

Solutions to externalities include;

1. Internalizing third party costs. A company can adopt some measures to eliminate cases of pollution like developing a drainage system to avoid spillage in water bodies.
2. The imposition of taxes. The government can impose tax on the items leading to the externality for example if a leather tanning industry is causing air pollution the government can impose a tax on the leather.