Economics 101 Practice Test: Externalities — Flashcards

In economics, an externality is a cost or benefit that affects a third party that is not directly involved in the activity that caused it. Externalities can be positive or negative. 

Externalities can be considered as unpriced components in consumer or producer market transactions. They can be tiny, but when they are large they can become problematic. Externalities are one of the main reasons governments intervene in the economic sphere. 

There are four main types of externalities: positive production, positive consumption, negative production, and negative consumption. 
 

Here are some examples of externalities:
Negative externality: Erosion and chemical runoff caused by building roads, which causes water pollution further downstream
Positive externality: Construction of a flyover or a highway reduces transport cost and journey time of its users