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Externality

AnalyticsTrade Team
AnalyticsTrade Team Last updated on 26 Apr 2023

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Externality

An externality is an economic term used to describe the cost or benefit of an action or transaction that affects a third party. It is a consequence of an economic activity that is not reflected in the market price of the goods or services involved. Externalities can be both positive and negative, and can affect either the producers or consumers of the goods or services. Examples of externalities include air pollution from factories, noise pollution from construction sites, and the benefits of public parks.

History of the Term

The term โ€œexternalityโ€ was first used by British economist Arthur Cecil Pigou in his 1920 book, The Economics of Welfare. Pigou argued that when a transaction or activity has an effect on a third party, the cost or benefit should be taken into account in the market price of the goods or services involved. He proposed a tax on activities that generate negative externalities, such as pollution, to internalize the cost of the activity and make it part of the market price.

Comparison Table

Type of Externality Cost/Benefit
Positive Benefit
Negative Cost

Summary

Externality is an economic term used to describe the cost or benefit of an action or transaction that affects a third party. It is a consequence of an economic activity that is not reflected in the market price of the goods or services involved. Externalities can be both positive and negative, and can affect either the producers or consumers of the goods or services. For more information on externalities, visit websites such as Investopedia, The Balance, and the Encyclopedia of Economics.

See Also

  • External Cost
  • External Benefit
  • Marginal Cost
  • Marginal Benefit
  • Social Cost
  • Social Benefit
  • Opportunity Cost
  • Market Failure
  • Public Good
  • Private Good

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