StellarExternalities
An externality is an economic side effect experienced by a third party who is not directly involved in the production or consumption of a good or service. Externalities occur when the private costs or benefits of an activity diverge from the social costs or benefits, creating inefficiencies in the market. They are categorized into two types: negative externalities, which impose costs on society, and positive externalities, which confer benefits.
Understanding externalities is critical for identifying instances of market failure and exploring how government interventions, such as Pigouvian taxes or subsidies, can correct these inefficiencies and move markets toward the socially optimal quantity.