What Is an Externality?

An externality is an effect of a purchase or use decision by one set of parties on others who did not have a choice and whose interests were not taken into account.  Put simply, externalities are spillover effects that fall on parties not otherwise involved in a market as a producer or a consumer of a good or service.  Externalities can be negative or positive, and externalities can result from either the production or the consumption of a good (or both).

 Negative externalities impose costs on parties not involved in a market, and positive externalities confer benefits on parties not involved in a market.

A classic example of a negative externality is pollution- pollution is generated by some productive enterprise and affects others who had no choice in the matter and were probably not taken into account in production decisions.

Examples of positive externalities are also easy to come by- for example, the production of Cinnabons emits a pleasant cinnamon aroma that people can enjoy even if they are not themselves consumers of the cinnamon rolls being produced.

Terms related to Externality / Externalities:

About.Com Resources on Externality / Externalities:

  • What is Wrong with the Coase Theorem?
  • Pigovian Taxes - Joining the Pigou Club
  • If Banning Incandescent Light Bulbs Saves Money, Is It Good Public Policy? No.

    Writing a Term Paper? Here are a few starting points for research on Externality / Externalities:

    Books on Externality / Externalities:

      Journal Articles on Externality / Externalities: