Externality

Figure 1. Reducing air quality is considered an externality, since the people polluting don't pay the consequences of polluting.

An externality is an effect that an economic transaction has on a party who is not involved in the transaction. Externalities deter a market from producing the equilibrium quantity and price for a good for service. Externalities produce inefficiencies in markets and can eventually produce a market failure if not internalized in time.

Externalities can be either positive or negative:

• Positive externality
• Negative externality

For Further Reading

• Market failure
• Pollution
• Deadweight loss
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