What is the term for the economic effect where one party's action influences another third party?

The term for the economic effect where one party's action influences another third party is known as externalities. Externalities occur when the actions of individuals or firms have unintended consequences that affect third parties who are not directly involved in the transaction. For example, pollution from a factory impacts the health and environment of nearby residents, who are neither the producers nor consumers of the factory's goods. This creates a cost that is not reflected in the market price, leading to an inefficiency in resource allocation.

Understanding externalities is crucial in economics because they illustrate potential market failures, where the market does not allocate resources efficiently on its own. Governments and policymakers often address externalities through regulations, taxes, or subsidies aimed at correcting these inefficiencies. The concept is essential for analyzing how economic activities can have broader social impacts beyond just the immediate parties involved.