Externalities are unintended side effects of an economic activity that affect third parties who are not directly involved in the activity.
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These effects can be either positive or negative.
- Positive Externalities: These occur when the benefits of an economic activity spill over to third parties. For example, education can have positive externalities as a more educated workforce may contribute to overall societal well-being.
- Negative Externalities: These occur when the costs of an economic activity affect third parties. Pollution from a factory impacting the health of nearby residents is an example of a negative externality.
Addressing externalities often involves government intervention, such as implementing taxes, subsidies, or regulations to internalize the external costs or benefits.