Explain the concept of externality.

Explain the concept of externality.

Externality refers to the impact of an economic activity on parties who are not directly involved in the activity and therefore do not receive compensation or bear the costs associated with it. It occurs when the actions of one party affect the well-being of others in a way that is not reflected in market prices. Externalities can be positive or negative. Positive externalities occur when the activity benefits third parties, such as when a person plants trees that improve air quality for the entire community. Negative externalities occur when the activity imposes costs on third parties, such as pollution from a factory that harms the health of nearby residents. Externalities can lead to market failures, as the market does not fully account for the costs or benefits imposed on others.