- "In economics, an externality or external cost is an indirect cost or benefit to an uninvolved third party that arises as an effect of another party's (or parties') activity."
The unintended consequences of economic transactions that affect people who are not directly involved in the transaction, such as pollution from production processes or traffic congestion.
Definition of Externalities: Describes the concept of how an economic activity can have positive or negative effects on parties outside of the marketplace.
Types of Externalities: Lists different types of externalities that can exist, such as positive, negative, production, and consumption.
Social Optimum: Defines the optimal level of production that maximizes social welfare.
Cost-Benefit Analysis: Examines the costs and benefits of an economic activity on society.
Coase Theorem: States that if there are no transaction costs, private parties can reach the same allocation of resources as under the social optimum, regardless of who has the property rights.
Market Failure: Describes when the market fails to produce an efficient outcome, usually due to externalities.
Property Rights: Discusses how property rights can help mitigate externalities if assigned correctly.
Pigouvian Taxes or Subsidies: Examines taxation or subsidization of activities that generate negative or positive externalities respectively.
Public Goods: Describes goods that meet certain criteria, such as non-exclusion and non-rivalry, that make market allocation challenging.
Tragedy of the Commons: Discusses how a shared resource can be depleted due to overuse.
Regulatory Approach: Examines how the government can intervene through regulations to address externalities and promote efficient outcomes.
Coordinating Approaches: Discusses non-regulatory approaches such as contracts, bargaining, and public awareness campaigns that may help mitigate externalities.
International Externalities: Describes how economic activities can have positive or negative effects on a global scale, and how they should be addressed.
Market-Based Instruments: Examines how externalities can be addressed through taxes, subsidies, and tradable permits.
Informational Approaches: Discusses how information can be used to address externalities, such as labels, certifications or disclosure requirements.
Positive externalities: A positive externality occurs when the consumption or production of a good or service provides benefits to third parties that are not reflected in the market price. For example, an individual who receives a vaccination benefits not only themselves but also those around them who are less likely to contract the disease.
Negative externalities: A negative externality is the opposite of a positive externality as the consumption or production of a good or service imposes costs on third parties that are not reflected in the market price. For example, pollution from a factory affects the health and well-being of people who live nearby.
Consumption externalities: A consumption externality occurs when the consumption of a good or service affects the utility or well-being of others. For example, a person smoking in a public space might affect the health of others who are exposed to the smoke.
Production externalities: A production externality occurs when the production of a good or service affects the utility or well-being of others. For example, a factory that produces pollution might affect the air quality and health of people who live nearby.
Network externalities: Network externalities occur when the value of a product or service increases as more people use it. For example, the value of a social networking site increases as more people join the platform.
Knowledge externalities: Knowledge externalities occur when creating knowledge or information results in benefits for others. For example, a scientist performing research in a particular field might discover new information that could be used by other researchers.
Public goods externalities: Public goods externalities arise when the consumption of a public good benefits others. Public goods include things like clean air, national defense, and public parks.
Technological externalities: Technological externalities occur when the development of a new technology benefits others. For example, the development of the internet has numerous benefits for individuals and businesses around the world.
Information externalities: Finally, information externalities occur when the dissemination of information results in benefits for others. For example, a medical discovery that is shared with the public can help people make more informed medical decisions.
- "Air pollution from motor vehicles is one example."
- "Water pollution from mills and factories is another example. All consumers are made worse off by pollution but are not compensated by the market for this damage."
- "A positive externality is when an individual's consumption in a market increases the well-being of others, but the individual does not charge the third party for the benefit."
- "An example of this might be the apartment above a bakery receiving the benefit of enjoyment from smelling fresh pastries every morning. The people who live in the apartment do not compensate the bakery for this benefit."
- "The concept of externality was first developed by economist Arthur Pigou in the 1920s."
- "Pigou argued that a tax, equal to the marginal damage or marginal external cost, (later called a 'Pigouvian tax') on negative externalities could be used to reduce their incidence to an efficient level."
- "Externalities are an example of market failure because the production or consumption of a product or service's private price equilibrium cannot reflect the true costs or benefits of that product or service for society as a whole."
- "Governments and institutions often take actions to internalize externalities, thus market-priced transactions can incorporate all the benefits and costs associated with transactions between economic agents."
- "The most common way this is done is by imposing taxes on the producers of this externality."
- "Once the externality is internalized through imposing a tax, the competitive equilibrium is now Pareto optimal."
- "However, since regulators do not always have all the information on the externality, it can be difficult to impose the right tax."
- "For example, manufacturing activities that cause air pollution impose health and clean-up costs on the whole society."
- "The neighbors of individuals who choose to fire-proof their homes may benefit from a reduced risk of a fire spreading to their own houses."
- "If external costs exist, such as pollution, the producer may choose to produce more of the product than would be produced if the producer were required to pay all associated environmental costs."
- "Because responsibility or consequence for self-directed action lies partly outside the self, an element of externalization is involved."
- "If there are external benefits, such as in public safety, less of the good may be produced than would be the case if the producer were to receive payment for the external benefits to others."
- "Externalities can be considered as unpriced goods involved in either consumer or producer market transactions."
- "Air pollution from motor vehicles is one example."
- "Externalities cause the externality competitive equilibrium to not adhere to the condition of Pareto optimality."