What are externalities?

Externalities are defined as costs or benefits that affect individuals who did not choose to be involved in a particular economic transaction. This means that these third parties, who are not directly engaged in the buying or selling of a good or service, still experience positive or negative effects. For instance, if a factory pollutes a river as a byproduct of its manufacturing process, the local community suffers from the negative consequences of that pollution, despite having no part in the transaction between the factory and its customers. On the other hand, if a homeowner plants a garden that beautifies the neighborhood, neighbors might experience the positive externality of improved aesthetics without being involved in the homeowner's decision to plant the garden.

The other options do not accurately describe externalities. While costs incurred by the government in regulation and economic advantages gained by monopolies are relevant economic concepts, they do not reflect the idea of costs or benefits affecting third parties. Benefits received by all participants in a market is also not an appropriate definition, as it implies that all parties are directly involved in the transaction rather than experiencing outside benefits or drawbacks.