What is externality?
A cost or benefit that lands on people who had no part in the decision that caused it, and so is left out of the price.
Externality diagram example
An externality is a side effect of an activity that falls on a third party and is not reflected in what the buyer or seller pays. A factory that pollutes a river is the classic negative case, and a neighbor who plants a garden everyone enjoys is a positive one. Externalities matter because decision makers who ignore them will produce too much of what harms others and too little of what helps them.
How it works
The decision maker compares private costs and private benefits only. When a cost is pushed onto someone else, the private cost looks lower than the true social cost, so the activity grows past the level that would be best for everyone. A positive externality works in reverse: the benefit leaks out to others, the producer is not paid for it, and the activity stays too small.
The usual remedies try to bring the outside effect back inside the decision. A tax or fee raises the private cost of a harmful activity, a subsidy lowers the cost of a helpful one, and a cap on total output limits the harm directly. In each case the fix works by changing a price signal or a limit, so you can test it by comparing outcomes before and after.
Example
Say a delivery company earns 10 per parcel and spends 6, so it keeps 4 per parcel. Each delivery also adds traffic and exhaust that cost the surrounding neighborhood 3 per parcel. The company sees a profit of 4 and ships as many parcels as it can. The true net gain is 4 minus 3, or 1 per parcel. If a fee of 3 per parcel is introduced, the company's private profit drops to 1 and it will drop the parcels that were worth less than the harm they cause. These numbers are an illustration only.
How to model it in Machinations
Use a Source for parcel demand and a Converter that turns parcels into deliveries, with a Pool called Company profit. Add a second Pool called Neighborhood harm that fills through a state connection tied to the number of deliveries, so the harm is visible even though the company does not pay for it. Create a Lever for the fee and a Drain that moves the fee from profit into a public Pool. Play with the fee at 0 and then at 3, and chart both Pools to see how volume and total harm change.
See externality in a system you can Play
Build the rules in a Machinations diagram, change a value and Play it to watch how the system responds.