An externality is a situation in which the behaviour of a person or firm affects the welfare of another person, or the profitability of another firm, without appropriate monetary compensation occurring. An externality is positive if some agent's behaviour makes another agent better off, and it is negative if that behaviour makes another agent worse off. Once you start looking, externalities are everywhere:

• Smokers like their nicotine “hit” but nearby non-smokers would prefer that they didn't get it.

• Someone playing music on a beach is emitting an externality – positive if you like the music and negative if you don't.

• Industrial emissions lower air and water quality, damaging our health and that of other species, and imposing additional costs on other firms who need clean air and water as part of their production processes.

• You would be happier if your neighbours were avid gardeners than you would be if they put their old clunkers up on blocks on their front lawns.

• You are better off if you are literate, but so are all the other people who have to deal with you, because they can communicate with you in writing.

• Inoculation protects you against communicable diseases. However, many diseases require a large, dense population of susceptible people before they can establish themselves. Since each inoculation reduces the population of susceptible people, it also protects (to some degree) people who choose not to be inoculated.

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