Is a cost/benefit that is imposed on third parties i.e. economic agents who were not involved directly in the production/consumption of the good.
The presence of an externality in a market signals market failure and therefore society's welfare is not being maximised.
There are four different forms of externalities that can arise in an economy:
- Negative Production Externalities
- Positive Production Externalities
- Negative Consumption Externalities
- Positive Consumption Externalities