Economists apply the term “externalities” to cases in which the actions of one agent impact another without their permission or agreement. Externalities can be either negative or positive, depending on whether the impact imposes a cost or benefit on the one affected. For example, if one person pollutes another person’s water source without their permission, the one affected experiences a negative externality. But if one person plants lots of trees and improves another person’s air quality without their permission, the person benefited experiences a positive externality.
Economists have theorized about many ways of addressing externalities that involve the agent creating them “internalizing” the costs or benefits generated, including taxes, regulation, and direct negotiations between the parties involved. For example, the government could impose a pollution tax or regulation that would make the polluter pay for the negative impact on the water source (and thus internalize the negative externality). Or, in the case of tree planting, the planter could be paid directly to seed extra trees (and would thus internalize the positive externality).
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