externalities Flashcards
what is a externality
An externality is a side effect or spillover from an economic activity that impacts individuals or groups who are not directly involved in the activity. Externalities can either be positive (benefits to others) or negative (costs to others) and can affect individuals, society, or the environment.
what is a negative externality
A negative externality occurs when an economic activity causes harmful side effects to third parties who are not part of the transaction. These costs are not reflected in the price of the good or service and can lead to market failure. Examples include pollution, noise, or health impacts.
Example:
Pollution from factories: A factory may emit pollutants into the air as a by-product of its production process, harming the health of nearby residents, even though they are not involved in the production or consumption of the factory’s products.
what is a positive externality
A positive externality occurs when an economic activity creates benefits for third parties who are not involved in the transaction. These benefits are not captured by the price of the good or service, leading to an under-provision of beneficial activities.
Example:
Vaccinations: When an individual gets vaccinated, they not only protect themselves from disease but also reduce the risk of spreading the disease to others, benefiting the wider community.
How do externalities lead to market failure?
Externalities lead to market failure because they create a mismatch between private and social costs or benefits. In the case of negative externalities, the market fails to account for the harmful side effects, leading to overproduction of goods that cause harm. In the case of positive externalities, the market underproduces goods that provide societal benefits because the producers don’t capture all the benefits they create.
For example, a polluting factory might produce more than what is socially optimal because it doesn’t bear the full cost of the pollution it creates. Conversely, a public good like education may be underprovided because the benefits spill over to society, but individuals might not be willing to pay for the full societal value of an educated population.
What are some examples of negative externalities?
Air Pollution: Emissions from vehicles, factories, and power plants can pollute the air, contributing to health problems and environmental damage.
Water Pollution: Industrial waste or chemical runoff can contaminate rivers, lakes, and oceans, harming aquatic life and ecosystems.
Noise Pollution: Airports, construction sites, and busy urban areas generate noise that can disturb surrounding communities and impact health.
Second-hand Smoke: People who are not smoking can still be affected by the smoke from others, leading to health risks like respiratory diseases.
Traffic Congestion: More cars on the road lead to delays for everyone, even those not involved in the decision to drive.
What are some examples of positive externalities?
Education: Individuals who gain an education not only benefit themselves but also contribute to a more skilled and productive workforce, which benefits society through higher productivity, lower crime rates, and more informed citizens.
Public Transportation: When more people use public transport, it reduces traffic congestion and lowers pollution, benefiting non-users as well.
Tree Planting: Individuals or companies that plant trees not only benefit from the aesthetic or environmental improvements but also provide cleaner air, greater biodiversity, and carbon sequestration, which benefit society.
Research and Development (R&D): Innovations or discoveries made by companies or individuals in fields such as medicine or technology often spill over into other industries, benefiting others who were not part of the original research.
Vaccination: As mentioned earlier, vaccinations not only protect the individual receiving them but also provide “herd immunity,” reducing the spread of diseases to others.
