What is an externality?

An externality refers to a situation where a third party is affected by the economic activities of others, without being compensated for that effect. This can manifest as either a cost or a benefit that spills over from a transaction. In the context of option B, it specifically highlights that an externality can impose costs or benefits on individuals or groups who are not directly involved in the transaction.

For example, if a factory emits pollution that affects the health of nearby residents, those residents experience a negative externality. They did not participate in the factory's decision-making and are not compensated for the harm caused by the pollution. Conversely, a positive externality might occur when a homeowner invests in landscaping that beautifies the neighborhood, benefitting their neighbors without any direct compensation.

The other options describe concepts related to externalities but do not capture the full essence of what an externality is. A focuses only on positive externalities, while C refers to a specific solution to pollution rather than defining an externality itself. D discusses benefits from public goods, which are separate from the concept of externalities as they are typically non-excludable and non-rivalrous goods provided to all, rather than effects on third parties from market transactions.