What does 'Externalities' refer to in microeconomics?

💡 Solution & Explanation

Externalities occur when the production or consumption of a good directly affects uninvolved third parties who neither pay for the cost nor reap the direct benefit of the transaction. Unlike internal accounting profits or international tariffs, externalities represent market failures because private costs or benefits diverge from social costs or benefits. A classic negative example is industrial pollution affecting local residents without compensation. Economics syllabi for civil services emphasize market failures and regulatory remedies.