Which term describes the spillover effects of a transaction on third parties?

• A. Opportunity cost
• B. Monopoly
• C. Externality
• D. Inflation

Answer: (C)

Externalities are spillover effects of a transaction on people who are not directly involved. These effects can be good or bad. When a business activity affects others outside the transaction, the market price may not reflect that impact, leading to outcomes that don’t maximize social welfare. For example, pollution from a factory imposes health and cleanup costs on nearby residents who aren’t paying for them, while getting a vaccination or education can create benefits for society beyond the individual who pays. The other terms don’t describe these spillover effects: opportunity cost is the value of the next best alternative, monopoly is a market with a single seller, and inflation is a general rise in prices.