What is the outcome when an economic activity imposes costs on third parties?

When an economic activity imposes costs on third parties, this situation is defined as a negative externality. Negative externalities occur when the actions of individuals or businesses have adverse effects on others who are not directly involved in the transaction or activity. For example, pollution from a factory can harm the health of nearby residents who are not part of the production process.

This concept highlights a fundamental issue in economics where the market fails to account for the social costs imposed by such activities, leading to overproduction or excessive consumption of goods or services that generate these external costs. The presence of negative externalities often calls for government intervention or policy measures to correct the market failure, such as regulations, taxes, or incentives to reduce the negative impacts on third parties.

In contrast, positive externalities occur when an activity confers benefits on third parties, which is not the case here. An external benefit is another term synonymous with positive externalities, while social gain refers to a broader benefit accruing to society rather than specifically addressing external costs. Thus, recognizing negative externalities is crucial for understanding market dynamics and the need for potential regulatory responses.