Final answer:
When there are significant costs involved with coordinating a private solution to an externality, such as pollution, market failure can occur because the market does not account for all social costs.
Step-by-step explanation:
When discussing the coordination of private solutions to an externality, we are referring to how private parties can address the spillover effects of their actions that affect third parties, such as pollution. These effects are not reflected in the market prices and can lead to market failure. In an ideal market scenario, the interaction of demand and supply will coordinate social and private costs and benefits. However, when externalities like pollution are involved, the supply curves no longer represent the full social costs. This means that the market does not produce the most efficient output, as it underestimates the real costs, which include environmental and health impacts that fall on society as a whole. To internalize these externalities and make the market work efficiently, it may be necessary to introduce policies that factor in these additional social costs, such as taxes, regulations, or tradable permits for pollution.
The challenge arises when significant costs are associated with coordinating a private solution to such an externality. These costs can be legal, transactional, or due to significant information asymmetries. The Free Rider Problem further complicates matters, especially with nonexcludable goods like national defense, where it is difficult for private companies to charge users directly. In the context of environmental externalities, when these social costs are included in a product's price, the market may achieve a more socially optimal level of production and consumption, but it often requires government intervention or collective action to ensure these external costs are accounted for.