An externality in economics refers to the indirect cost or benefit to an uninvolved third party that arises as a result of another partys activity. Externalities can be positive or negative. A positive externality occurs when an individuals consumption in a market increases the well-being of others without charging the third party for the benefit. An example of this is the enjoyment experienced by people living above a bakery due to the smell of fresh pastries every morning. On the other hand, a negative externality is any difference between the private cost of an action or decision to an economic agent and the social cost. This can include things like toxic gases released from industries or mines, which cause harm to individuals in the surrounding area and impose an indirect cost on them to mitigate the harm.
Externalities can be generated during the production or consumption of a good or service. They can be both private, affecting an individual or an organization, or social, impacting society as a whole. Governments and companies can address externalities through financial and social measures.
In summary, externalities are important in economics as they represent the indirect effects of economic activities on third parties, and they are a key reason for government intervention in the economic sphere.
