An externality is defined as an effect of an economic activity that is experienced by a third party, who did not choose to participate in the activity. This effect can be either positive or negative, and can occur even if it wasn’t intended. For example, when a company expands its production process, it might lead to increased pollution. This increased pollution is an unintended consequence for those living in surrounding areas, and therefore could be classified as an externality. Generally speaking, externalities lead to inefficient resource allocation and misallocation of costs and benefits. This means that those responsible for the externalities bear no financial burden, while those affected must bear the burden of the negative externality. It is essential to factor in externalities when considering the costs and benefits of any economic activity or proposed policy.