Question

Define the concept of ‘Externalities’.

Hint:

Externalities are benefits or harms caused by one entity to another without being paid for the benefit or penalised for the harm.

Answer 1

Step 1: Understanding the Concept:
Sometimes the act of one person or firm, in production or consumption, affects other people who were not part of the deal.
Such side effects are called externalities.

Step 2: Definition.
Externalities are the benefits or harms caused by one entity to another, without the first entity being paid for the benefit or penalised for the harm.
The word "entity" can mean a person, a firm or the government.

Step 3: Two kinds with examples.
A positive externality is a benefit given free to others. Example: a neighbour plants a garden and the whole street enjoys cleaner air.
A negative externality is a harm imposed on others without penalty. Example: a factory releases smoke and the people nearby fall ill, yet the factory pays nothing for it.

Final Answer:
Externalities are benefits or harms that one entity causes to another, for which it is neither paid nor penalised.