What is a positive externality?

A positive externality occurs when an economic activity leads to a beneficial effect on individuals or groups who are not directly involved in the transaction. This can happen, for instance, when a person cultivates a beautiful garden that neighbors enjoy, even if they did not pay for it or participate in its maintenance. The benefits of the garden enhance the overall wellbeing of the community, illustrating how positive externalities contribute to social welfare.

Recognizing positive externalities is crucial because they highlight the value of certain activities that may not be fully captured by market prices. They often warrant attention from policymakers who may want to encourage such beneficial activities through incentives or subsidies, thus promoting broader societal benefits.