In economics, an externality (or transaction spillover) is a cost or benefit, not transmitted through prices, incurred by a party who did not agree to the action causing the cost or benefit. The benefits of externalities, in this case, is called a positive externality or external benefit, while its cost is called a negative externality or external costs.

In these cases of both negative and positive externalities,in a competitive market, prices do not reflect the full costs or benefits of producing or consuming a product or service. Also, producers and consumers may neither bear all of the costs nor reap all of the benefits of the economic activity, and too much or too little of the goods will be produced or consumed in terms of overall costs and benefits to society. For example, manufacturing that causes air pollution imposes costs on the whole society, while fire-proofing a home improves the fire safety of neighbors. If there exist external costs such as pollution, the good will be overproduced by a competitive market, as the producer does not take into account the external costs when producing the good. If there are external benefits, such as in areas of education or public safety, too little of the good would be produced by private markets as producers and buyers do not take into account the external benefits to others. Here, overall cost and benefit to society is defined as the sum of the economic benefits and costs for all parties involved.

Adjective

external (comparative more external, superlative most external)

1. outside of something

• internal

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