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Answer: What are externalities, and how do they affect who pays the true cost of a polluting factory?
Externalities are the market effects felt either beneficially or detrimentally by third parties in a market exchange. Another way to look at this is that externalities are by-products affecting bystanders. An example would be when a factory gets rid of production waste more cheaply by polluting a river than by disposing of the waste in a manner that does not affect the environment. By polluting the river, the factory has a lower internal cost of production, a lower price of output, and thereby a larger quantity demanded of its product. What is not in the final price of the product is the external cost of the pollution paid by those living downstream and suffering health costs and loss of income.
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