Externality
A cost or benefit imposed on third parties not involved in an economic transaction.
What is Externality?
An externality is a consequence of an economic activity that affects parties outside the transaction, without being reflected in market prices. Negative externalities — such as air pollution from a factory — impose costs on society that the producer does not pay, leading to overproduction. Positive externalities — such as the community benefits of education or vaccination — lead to underproduction because producers cannot capture the full social value. Externalities are a primary cause of market failure. Common policy responses include Pigouvian taxes on negative externalities, subsidies for positive ones, direct regulation, and cap-and-trade systems designed to internalize external costs into market prices.
Example
A coal power plant generates electricity at $0.05 per kWh in private costs. However, its pollution causes $0.03 per kWh in health and environmental damage borne by society. The true social cost is $0.08 per kWh, but the plant charges $0.05. This negative externality leads to overconsumption of coal-generated electricity relative to the socially optimal level.
Source: Investopedia — Externality