Negative Externality

When a business or individual does something that harms others without paying for the harm, a negative externality occurs. The price of the product does not reflect its full cost to society.

Pollution is the classic example. A power station that burns coal may produce cheap electricity, but the air pollution it creates can damage health, crops and the climate. Those costs fall on people who did not choose them. Other examples include traffic congestion, noise from a nightclub and second-hand smoke.

Because the producer or user does not bear the full cost, the activity happens more than would be ideal for society. Drivers do not pay for the delays they cause others in heavy traffic, so roads become more congested than they would if each driver paid the full cost.

Governments address negative externalities through taxes, such as carbon taxes or fuel duties; regulations, such as emission limits; tradable pollution permits; and charges, such as congestion charges in city centres. The goal is to make those who cause the harm take its cost into account.