When a person tries to achieve his goals, side-effects or by-products sometimes occur that affect others. In these cases, the person making decisions either may not know about the side-effects or may not care enough about them to let them influence his decisions. An important example of a side-effect is the production of pollution.

Pollution is not an intended product, but it is one output in a production (or consumption) process. Consider, for example, the production of electricity from coal. Among the outputs of this production process are electricity, heat, carbon dioxide, and ash. The type of coal used will influence the outputs—some coal is high in sulfur, which will emerge in some form as an output. The electricity is the desired output, and the others are usually unwanted outputs that cannot be totally avoided. If one of the outputs is considered undesirable, it can sometimes be controlled, but this process will create other by-products.

Pollution refers to by-products that are considered undesirable to others. If no one considers the waste heat that is a by-product of the production of electricity a problem, that waste heat will not be called pollution. When it is considered a problem, the government may force the electric utility to use resources to deal with it by building cooling towers, for example. A cooling tower does not, of course, reduce the total waste heat. It only transfers some of it from the water to the air where it is considered to be less undesirable.

By-products do not have to be harmful; they can be helpful or neutral. An important instance of a non-harmful by-product is the creation of money. Money in modern economies arises as an unintended result of banks making loans. This aspect of banking is important to economists because they have evidence that changes in the amount of money influences the amount of inflation and unemployment that a society has.

Economists have a special name for these byproducts or spillover effects: externalities. As the name suggests, an externality exists when either an unintended cost is imposed or an unintended benefit is given in the process of producing or consuming. Because the realization that externalities are everywhere has greatly influenced economic thinking, we will examine them in several places later in these pages. We finish this set of pages with a look at one important case of the by-product phenomenon, the problem of the commons.

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