Externality

In economics, an externality is a cost or benefit to an uninvolved third party that arises as an effect of another party's (or parties') activity. Many externalities can be considered as unpriced components that are involved in either consumer or producer consumption. Air pollution from motor vehicles is one example. The cost of air pollution to society is not paid by either the producers or users of motorized transport. Water pollution from mills and factories are another example. All (water) consumers are made worse off by pollution but are not compensated by the market for this damage.

The concept of externality was first developed by Alfred Marshall in the 1890s and achieved broader attention in the works of economist Arthur Pigou in the 1920s. The prototypical example of a negative externality is environmental pollution. Pigou argued that a tax, equal to the marginal damage or marginal external cost, (later called a "Pigouvian tax") on negative externalities could be used to reduce their incidence to an efficient level. Subsequent thinkers have debated whether it is preferable to tax or to regulate negative externalities, the optimally efficient level of the Pigouvian taxation, and what factors cause or exacerbate negative externalities, such as providing investors in corporations with limited liability for harms committed by the corporation.