compensation

social costs costs that include both the private costs incurred by firms and also additional costs incurred by

third parties outside the production process, like costs of pollution

spillover see externality

Key Concepts and Summary

12.1 The Economics of Pollution

Economic production can cause environmental damage. This tradeoff arises for all countries, whether high-

income or low-income, and whether their economies are market-oriented or command-oriented.

An externality occurs when an exchange between a buyer and seller has an impact on a third party who is not

part of the exchange. An externality, which is sometimes also called a spillover, can have a negative or a

positive impact on the third party. If those parties imposing a negative externality on others had to account for

the broader social cost of their behavior, they would have an incentive to reduce the production of whatever is
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