According to Economist Vilfredo Pareto, a condition of ‘Pareto Optimality’, which refers to efficient allocation of natural resources such that no reallocation of resources of such could benefit any person without lowering the net benefits for at least one other person, cannot be attained in the presence of Externalities. Explain how externalities affect the condition of Pareto Optimality using suitable examples of each type of the externalities.

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Market Failure Analysis

To understand Market failure, we need to first understand welfare economics. An Italian economist, Vilfredo Pareto stated that allocation of resources in an efficient manner such that an economic change, which harms no one and makes someone better off, indicates an increase in social welfare. It is also called Pareto Optimality, where resources cannot further be reallocated without harming one. This does not apply to those economic changes, which harm some and benefit others. social welfare increases if the utility of any of its members' increases and none decrease in the economy.