Definition
Externality
A cost or benefit that falls on a third party not involved in a market transaction.
Definition
A cost or benefit that falls on a third party not involved in a market transaction.
Why It Matters
When markets create externalities, the private price diverges from the social cost, leading to overproduction of harmful goods or underproduction of beneficial ones. Externalities are a core justification for government intervention.
Policy Example
Education generates positive externalities: a more educated population benefits society through lower crime, better civic participation, and faster innovation — benefits that individual students do not fully capture in their own wages. This is why education is publicly subsidized.
In Context