Externality

Externality is a concept in economics that describes a side effect or consequence of an industrial or commercial activity that affects other parties without this being reflected in the cost of the goods or services involved, such as the pollution emitted by a factory that spoils the surrounding environment and affects the health of nearby residents.

Definition

An externality can be both positive or negative, and both can have significant impacts on the public welfare and economic efficiency. A positive externality provides a positive effect on the third party. For example, an individual who maintains their property well not only benefits, but also adds to the value of adjacent properties. A negative externality imposes a negative effect on the third party. For example, factories emitting smoke and disturbing the environment is a negative externality.

Types of Externalities

There are several types of externalities in economics:

• Production Externalities: A production externality is a side effect from production that affects someone other than the producer, but for which the producer does not pay the costs. For example, a factory that pollutes the environment creates a cost to society, but the factory does not pay these costs.

• Consumption Externalities: A consumption externality is a side effect from consumption that affects someone other than the consumer, but for which the consumer does not pay. For example, smoking in public places can create health risks for others.

Dealing with Externalities

There are several ways to deal with externalities:

• Government Intervention: The government can play a role in reducing negative externalities by taxation, regulation, and legislation.

• Private Solutions: Such as the Coase Theorem, which argues that under conditions of competitive markets with no transaction costs, an efficient set of inputs and outputs to and from production-optimal distribution are selected.

See Also

• Market Failure
• Public Goods
• Tragedy of the Commons

References

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