What is an Economic Externality?
To answer this question, let’s take a quick step back to understand the economy and how market participants interact. In the case of oil, we all need it for our vehicles – oil to lubricate the engine and gasoline to make it run. We purchase these products at service stations and pay a few dollars per gallon. The parties involved in this business include us (consumers) and all of the people, land, and equipment that produce the gasoline (factors of production). Anyone or anything not directly involved in the production or purchase are considered ‘external’ to the transaction. The previous sentence is a layman’s version of the definition, but to really answer the initial question, let’s expand this into terms used by economists. From Baumol and Blinder’s Economics Principles and Policy, 11th Edition: “An activity is said to generate a beneficial or detrimental externality if that activity causes incidental benefits or damages to others not directly involved in the activity, and no corres
