DEFINITION of 'Production Externality'

Costs of production that must ultimately be paid by someone other than the producer of a good or service. Production externalities are usually unintended and can have economic, social and environmental side effects. Production externalities can be measured in terms of the difference between the actual cost of production of the good and the real cost of this production to society at large.

BREAKING DOWN 'Production Externality'

There are many examples of externalities, such as pollution and depletion of natural resources. A logging company can pay for the cost of a tree that they remove, but the cost of replacing an entire forest once it is gone is exponentially more than the sum of its lost trees. Freeway traffic jams and health problems that arise from breathing secondhand smoke are further examples of externalities in production.

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