Production externality is an economic concept referring to the impact of an industrial operation on an unrelated third party. In other words, production externalities are the costs of production that are not borne by the producer, but are instead borne by society at large. These external costs may arise from environmental pollution or other activities that produce negative effects on unrelated third parties.

For example, when a chemical company releases an improperly stored toxic chemical into the water table, or when an oil refinery produces air pollution that negatively affects nearby residential areas, the direct costs of production (in terms of equipment and labor costs) are not borne by the producer, but are instead passed off as costs to the environment and to nearby residents. The cost of production externalities is rarely included in the price of a good, and thus is typically borne by society at large in the form of health problems, decreased property values and other negative effects.

The true extent of production externalities is often difficult to quantify, as the effects are often dispersed over a wide geography, and the effects may be felt for many years. Even when environmental pollution is identified, measuring the cost in terms of human suffering, decreased property values and other long-term effects is exceedingly difficult. Economists have attempted to estimate the value of production externalities by looking at the damage done to the environment, the effects on property values, and estimating the lost potential use of resources, among other measures.

Ultimately, production externalities can take many forms and understanding their effects on different populations can be difficult. However, quantifying their impacts is necessary to ensure that the costs and benefits of production activities are properly weighed and that society is held accountable for any negative externalities produced by firms. With a more complete understanding of production externalities, more efficient policies might be implemented to minimize the costs and maximize the benefits of industrial production.