What are externalities in economics and what do they mean?

Firstly, in order to start this article and for the article to make more sense, I will define exactly what externalities are and how they apply to economics. Externalities occur when an unintended side effect happens when consuming a good therefore affecting third parties. An example of that could be when consuming a cigarette, there are negative effects on the environment and on the people around you. In this specific case, the two original parties are the sellers (cigarette company) and the consumer. However, as mentioned smoking cigarettes not only negatively affects your health but the health of other people around you which, in this specific scenario, are the third party. In economics, this specific case of externality is called a negative externality of consumption.

There are two types of externalities which are the negative externalities to society and the positive externality to society. I will explain how positive externalities to society work and then explain how negative externalities work.

Positive externalities are when there are positive impact on the environment or on society. It is the opposite of a negative externality. An example of a positive externality is for example when teacher receive training before starting to teach. Here the two original parties are the school offering the training and the teacher who receives the training. The third party could be the students for example. A teacher with better training will generally give the students a better education and better lessons in general than a teacher with less training experience. Goods or services with positive externalities are undersupplied (meaning that the demand is higher than the quantity supplied) simply because it is expensive and can affect a firms position in the market. For example, looking back at the teachers training, when schools decide to offer teachers training it is expensive and if the teacher decides to change school after a short amount of time, the teacher will carry the training with him everywhere and might offer better education elsewhere.

Contrastingly, negative externalities are oversupplied. They affect negatively the society and sometimes the environment. An example for this would be cigarettes or cigars which I previously mentioned in my introduction but another example could be firms polluting the environment in the process of making or developing a certain good.

Externalities can be explained much further in economics and with much more precise economic terminology but this article only outlines how each externality works. I chose to write about this because I find externalities to be very interesting in economics and because it isn’t a very complicated topic of economics. I also would also like to specify that all this article only discusses externalities when looking at micro-economics.