The fundamental economic problem is the issue of scarcity yet limitless wants.

Scarcity means that there

is only a small amount of capital, for example finite fossil fuels. There is a constant cost of opportunity
due to scarcity – if you are using capital to consume one product, you cannot consume another.
Therefore, an economics underlying function is grappling with how to distribute resources in society to
make the most effective and equitable use of resources. The main issues are:

1. What to produce?

2. How to produce?

3. For whom to produce?

The economic problem of pollution

One of the most commonly faced issues is that economic decisions can have negative consequences on
other individuals outside the transaction. For instance, if you generate coal power, the pollution
negatively impacts people around the world (acid rain, global warming). This is a unique challenge,
because we cannot rely on the free market to produce the most effective results. If we create negative
externalities, we do not take them into account when determining how much to consume. This is why
we can get overconsumption of driving a car into a city center at peak hour. If everyone maximizes their
usefulness, it does not result in the most efficient outcome – but gridlock and wasted resources.

Externalities, usually need some sort of government intervention. For example, taxes on negative
externalities (e.g. sugar tax) or incentives on positive externalities (e.g. free public education) also ban
cars in urban centers.

Private markets provide an effective way to put together buyers and sellers and decide what products
are made, how they are produced and who is getting them. A basic building block of economic theory is
the idea that voluntary exchange benefits both buyers and sellers. But what if a voluntary exchange
affects a third party who is neither the buyer nor the seller?

For example, imagine, a concert promoter who wants to create an outdoor arena where country music
concerts are held half a mile from your neighborhood. These outdoor concerts can be heard while sitting
on your back porch — or maybe even in your dining room. In this situation, concert ticket sellers and
consumers can both be very satisfied with their voluntary exchange, but you have no voice in their
business transaction.

An externality is called the effect of a market exchange on a third party that is outside or external to the
exchange. Since externalities arising in market transactions impact other parties outside of those
involved, they are often called spillovers.

Pollution is a negative externality. Economists demonstrate the social costs of production with a
demand and supply diagram. Social costs include the company's private production costs, and the
external emissions costs that are passed on to society.
The diagram below illustrates the demand and supply for manufacturing refrigerators. The demand
curve, D shows the quantity demanded at each price. The supply curve, S indicates the quantity of
refrigerators supplied by all the firms at each price if they only take into account their private costs and
are allowed to produce emissions at zero cost. The market equilibrium, E0 where the supplied quantity
and the demanded quantity are equal, is at a price of $650 and 45,000.
The situation is not actually so simple.