Externalities
Definition
Externalities are the unintended consequences of economic activities that affect third parties who are not directly involved in the transaction. They can be positive (beneficial) or negative (harmful).
Analogy
Imagine you live next to a bakery. The delicious smell of freshly baked bread is a positive externality because it brings joy to your day, even though you didn't buy any bread.
Related terms
Public Goods: These are goods or services that are non-excludable and non-rivalrous, meaning they benefit everyone and cannot be consumed by one person without benefiting others.
Market Failure: This occurs when the allocation of resources in a market is inefficient, leading to an undesirable outcome.
Pigouvian Tax/Subsidy: A tax or subsidy imposed on goods or activities with negative/positive externalities to internalize the costs/benefits.
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