Externalities and Social Costs

The economic ideas of externalities and social costs derive from the notion that the individual's pursuit of his or her self-interest does not always work to the best interests of society—that there are spillovers to other members of society resulting from the individual's actions. These externalities may be positive—such as with education (where society as a whole, as well as the individual, benefits from an individual's education)—or negative—as when goods production results in pollution. The issue, from an economic perspective, is that the presence of externalities creates a divergence between private perceptions of benefits and costs, on one hand, and social perceptions of benefits and costs, on the other.

Externalities are one facet of the broader concept of “market failure,” which reflects the failure of the ...