Final answer:
An externality occurs when a transaction between a buyer and seller affects a third party. It can be positive or negative. Parties causing negative externalities would reduce production if they had to account for social costs, while parties causing positive externalities would increase production if they were compensated for those benefits.
Step-by-step explanation:
An externality occurs when an exchange between a buyer and seller has an impact on a third party who is not part of the exchange. It can have a negative or positive impact on the third party. If those parties imposing a negative externality on others had to account for the broader social cost of their behavior, they would have an incentive to reduce production. In the case of a positive externality, the third party obtains benefits from the exchange between a buyer and seller without paying for them. This can lead to underproduction. If the parties generating benefits would receive compensation, they would have an incentive to increase production.
An externality is a situation where an economic activity impacts individuals that are not directly involved in the transaction. It occurs when the benefits or costs of an economic activity are external and not felt by c. All participants in the market, both producers and consumers. Externalities can be either negative or positive. Negative externalities, like pollution from a factory, affect third parties without compensation, leading to market inefficiency. On the other hand, positive externalities provide unaccounted-for benefits, such as the knowledge spillover from education, which could lead to underproduction since the demand by third parties isn't reflected in the market.