Mada za sehemu hiiEnvironmental EconomicsMada 4
In economics, externalities are the costs or benefits not transmitted through prices, incurred by a party who did not agree to the action.
Alternatively, externalities are advantages or disadvantages people may receive without participating in the activities that result in those costs or benefits.
Externalities are alternatively called spillover. In this case, in a competitive market, price does not reflect the full cost or benefits of producing or consuming products or services. Producers and consumers may either not bear all of the costs or benefits of the economic activities, and too much or too little of the goods will be produced or consumed in terms of overall cost or benefits to society.
For example, manufacturing that causes pollution imposes cost on the whole society, while fireproofing a home improves the fire safety of neighbors and is considered an externality.
There are two main types of externalities, these are:
- Positive externality
- Negative externality
These are benefits or advantages people enjoy without incurring any cost (payment). In this case, positive externalities increase the utility of the third party at no cost to them.
In positive externalities, social welfare increases but producers have no way of monitoring the benefits. Positive externalities are also called external benefits or spillover benefits.
Examples of positive externalities are education, health initiatives, law enforcement, environmental conservation, etc.
Illustrative Example of Positive Externality
When a person plants trees which results in conducive weather conditions, people enjoy such conditions freely without any cost.
A factory located in a certain area may bring benefits to the people of that area through enjoying improved infrastructure or getting employment.
These are costs or disadvantages incurred by a party who did not agree to the action causing the cost. Negative externalities are considered as disadvantages people incur without their will, mostly caused by a production process, sometimes even consumption.
Negative externality is also called spillover cost or public bad.
Illustrative Examples of Negative Externality
When an industry causes pollution in the production process, this is considered as negative externality because the pollution imposes cost or disadvantage to the whole society, e.g., disease.
Another example of negative externality is when there is discharge of polluted or unclean water in water bodies from industries, which results in the loss of living organisms while there is no compensation claimed for the loss occurred.
Standard economic theory states that any voluntary exchange is beneficial to both parties involved in trade. If it does not benefit both, however, an exchange can cause additional effects on third parties. From the perspective of those affected, these effects may either be positive (positive externality) or negative (negative externality). Welfare economics has shown that those who suffer from externalities imply no voluntary exchange in an economy.
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