External Costs

External costs, also known as negative externalities, refer to the unintended adverse effects of an economic activity that impact third parties not directly involved in the transaction. For example, if a factory pollutes a river, nearby residents who rely on that water suffer health issues and reduced property values. These consequences are not reflected in the market price of the factory's products, leading to a situation where the true cost of production is underestimated. Addressing external costs often involves regulation or taxes to encourage businesses to consider the broader societal impacts of their actions.