Which of the following terms is closely related to market failure?

Market failure refers to a situation where the allocation of goods and services by a free market is not efficient. Externalities are a key concept in understanding market failure, as they arise when the actions of individuals or firms have effects on third parties that are not reflected in market prices.

For instance, when a factory pollutes a river, the surrounding community suffers from the negative impacts of that pollution, such as health problems and loss of recreational opportunities, without having any way to influence the factory's decision or receive compensation. This creates a divergence between private and social costs, leading to overproduction of harmful goods and an inefficient allocation of resources.

Understanding externalities helps to illustrate the broader implications of individual decisions in a market setting, highlighting why some markets might not function optimally and necessitating government intervention or policy measures to correct the failure. Other terms, like internalities or monopolies, have their own roles in economic discussions but do not capture the essence of market failure related to third-party effects as directly as externalities do.