Legal Definitions - externality

An externality is a consequence or side effect of an economic activity that affects someone who is not directly involved in that activity. These effects can be positive or negative and can be social or monetary in nature.

• Negative externality: A factory dumps waste into a nearby river, polluting the water and harming the fish population. The people who live downstream from the factory are negatively affected by this pollution, but the factory does not pay for the damage it causes.
• Positive externality: A homeowner plants a beautiful garden in their front yard, which improves the appearance of the entire neighborhood. The other homeowners in the neighborhood benefit from the improved aesthetics, but the homeowner who planted the garden does not receive any compensation for their efforts.

These examples illustrate how externalities can impact people who are not directly involved in an economic activity. In the case of the negative externality, the factory is causing harm to others without paying for the damage it causes. In the case of the positive externality, the homeowner is providing a benefit to others without receiving any compensation for their efforts.