Externality

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An externality is a side-affect of some activity that affects one or more third parties who did not consent to or participate in the activity.

Externalities are an important concept in economics, because they represent situations where the full positive or negative affect of a certain transaction is not represented in the prices. Some proposed remedies are taxes, subsidies, and regulations.

There are positive (beneficial) externalities and negative (bad) externalities.

A supply and demand curve, which factors in the externality by separating out supply across marginal private cost and marginal social cost

Examples of negative externalities:

  • A factory that pollutes drinking water. This activity hurts the people who drink the water. They did not consent to the factory production, and the harm to them is not initially factored into the costs to the factory.
  • An unvaccinated person catches a disease and spreads it to another person (see virality).
  • An arson sets their home on fire which spreads to neighboring homes.

An externality could be viewed as a form of not coercion by side-affect.

Obtaining from activities that cause externalities are often part of a collective action problem. If everyone obtains from activities with externalities, everyone is helped, but there is a coordination problem in enforcing that.