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In the presence of a positive externality, the free market fails to achieve a socially optimal allocation of resources. Since producers and consumers only consider their private benefits and costs, they do not account for the external benefits bestowed upon third parties. As a result, the equilibrium quantity produced and consumed in the market is lower than the quantity that would maximize total social welfare, leading to a deadweight loss.

Market Failure due to Positive Externalities

In a market where the production of a good generates a significant positive externality, the quantity produced by private firms operating in their own self-interest will be equal to the socially optimal quantity.

When the production or consumption of a good creates a benefit for a third party not involved in the transaction, the market will tend to produce a quantity that is ________ than the amount considered ideal for society as a whole.

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