Imagine that you wake up one morning and you look outside. There is this beautiful substance falling from the sky. You grab your jacket and head out the door. With your mouth open you look up and take in some delicious…. chocolate.
Yes! That happened just this week. In a town in Switzerland where they produce Lindt chocolates, there was a malfunction at the chocolate factory, and the town was dusted in chocolate (CBS News)
Typically, when we think about factories emitting dark substances into the air, we think about pollution… a bad thing. We call this an externality.
Warning: Econ Definition. An externality is when the consumption or production of a good affects a third party not involved (and it isn’t reflected in the price).
Eyes glaze over.
In other words, an external party is impacted when someone makes something or consumes something.
An equilibrium price and quantity in a market occurs where the marginal value to consumers is equal to the marginal cost of production. But, when we have something like pollution, there is an extra negative cost to society beyond the cost to the firm of production. What that means is that society would be better off if less was produced (aka: reduce pollution).