What are externalities in economics?

Externalities in economics refer to costs or benefits that affect third parties who are not directly involved in a transaction. These can be positive, such as when a neighbor’s well-maintained garden enhances the value of nearby properties, or negative, like pollution from a factory that impacts the health of nearby residents.

The concept of externalities is crucial because it highlights the impact that individual or business actions can have on the welfare of others, which is not reflected in the market price of goods or services. For example, when a factory pollutes a river, it imposes costs on the community that the factory does not pay for, leading to market inefficiencies. Understanding externalities is important for creating policies that can mitigate negative impacts or promote positive effects, such as through taxation or subsidies.

The other options, while related to economic concepts, do not define externalities accurately. Government interventions, taxes, and regulations can all be tools to manage or control externalities, but they are not themselves descriptions of externalities. Instead, they are responses to the issues that arise from externalities in the market.