Water droplets in the air (either suspended in a cloud or more often falling as rain) act like millions of tiny prisms and split the white sunlight (which is a mix of lots of different colours (or wavelengths) of light.
When the light enters the water droplet it undergoes a process called ‘refraction’, then it reflects off the back of the drop and is ‘refracted’ again as it leaves the drop. The upshot of all this is that the path of the light is bent – but blue light is bent more than red light, and so all the colours contained within the white light are ‘smeared out’ based upon their colour or wavelengths.
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