What is a positive externality?

A positive externality is defined as a benefit that affects a party who did not choose to incur that benefit. This scenario occurs when an economic activity creates advantages for third parties who are not directly involved in the transaction.

For example, if a homeowner decides to plant a beautiful garden, the neighbors benefit from the increased aesthetic appeal and potentially higher property values. The homeowner incurs the costs and responsibilities of the garden, but the positives extend to others in the community without those individuals taking any action to receive this benefit.

Understanding positive externalities is crucial in economics because they can lead to underproduction of goods or services that generate these benefits. Markets may fail to allocate resources efficiently in the presence of positive externalities because the individuals or firms that generate them may not receive adequate compensation. This is where government intervention or policy measures might be necessary to encourage activities that generate positive externalities, such as subsidies or tax incentives.