Economics
Externalities
Externalities are the unintended side effects of economic activities that affect third parties not involved in the transaction. They can be positive (benefits) or negative (costs) and are not reflected in the market price. Externalities can lead to market inefficiencies and the need for government intervention to internalize these external costs or benefits.
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12 Key excerpts on "Externalities"
eBook - PDF- Kumar, A(Authors)
- 2021(Publication Date)
- Daya Publishing House(Publisher)
Chapter 3 Externalities Meaning, Sources and Types Externalities arise when certain actions of producers or consumers have unintended external (indirect) effects on other producers or/and consumers. Externalities may be positive or negative. Positive externality arises when an action by an individual or a group confers benefits to others. A technological spillover is a positive externality and it occurs when a firm’s invention not only benefits the firm but also enters into the society’s pool of technological knowledge and benefits the society as a whole. Negative Externalities arise when an action by an individual or group produces harmful effects on others. Pollution is a negative externality. When a factory discharges its untreated effluents in a river, the river is polluted and consumers of the river water bear costs in the form of health costs or/and water purification costs. In an activity generating positive externality, social benefit is higher than private benefit and in an activity generating negative externality, social cost is higher than private cost. Thus, in the presence of Externalities, social benefits (costs) and private benefits (costs) differ. The divergence between private benefits (costs) and social benefits (costs) results in inefficiency in resource allocation. Producers of Externalities do not have any incentive to take into account the effects of their actions on others. In a competitive market economy, private optimum output is determined at the point where marginal private cost equals price. When a positive externality occurs, the marginal social benefit will be higher than the marginal private benefit (price) and hence the private optimal output will be lower than the social optimal output. When a negative externality occurs the marginal social cost will be higher than the marginal private cost (price) and This ebook is exclusively for this university only. Cannot be resold/distributed.
eBook - PDF- John Leach(Author)
- 2003(Publication Date)
- Cambridge University Press(Publisher)
Externalities An externality is a situation in which the behaviour of a person or firm affects the welfare of another person, or the profitability of another firm, without appropriate monetary compensation occurring. 1 An externality is positive if some agent’s behaviour makes another agent better off, and it is negative if that behaviour makes another agent worse off. Once you start looking, Externalities are everywhere: • Smokers like their nicotine “hit” but nearby non-smokers would prefer that they didn’t get it. • Someone playing music on a beach is emitting an externality – positive if you like the music and negative if you don’t. • Industrial emissions lower air and water quality, damaging our health and that of other species, and imposing additional costs on other firms who need clean air and water as part of their production processes. • You would be happier if your neighbours were avid gardeners than you would be if they put their old clunkers up on blocks on their front lawns. • You are better off if you are literate, but so are all the other people who have to deal with you, because they can communicate with you in writing. • Inoculation protects you against communicable diseases. However, many diseases require a large, dense population of susceptible people before they can establish themselves. Since each inoculation reduces the population of susceptible people, it also protects (to some degree) people who choose not to be inoculated. • Trails opened to mountain bikers typically widen and turn to mud, and tree falls become more numerous because of damage to their root systems. The mountain biker is just looking for a thrilling ride, but leaves behind imperceptible damage which is devastating in its cumulative impact. • Each car entering the freeway system at rush hour slows the others down (again, almost imperceptibly) with the result that the same trip can take several times longer during rush hour than it would during slack times.
eBook - PDFIntermediate Microeconomics
A Tool-Building Approach
- Samiran Banerjee(Author)
- 2021(Publication Date)
- Routledge(Publisher)
Chapter 14 Externalities An externality is the ac com pa ny ing im pact (whether pos i tive or neg a tive) of one agent’s con sump tion or pro duc tion ac tiv ity on the util ity or tech nol ogy of an other, where this impact is independent of markets or prices. A global example that jumps out at us from the Covid-19 pandemic is a person who has been infected by the SARS-CoV-2 virus but is asymptomatic. They can infect many others by riding public transport, for example, causing serious illness or death among the elderly, a negative externality. When a person gets a flu shot, they not only reduce their own chances of catching the flu, but also reduce the likelihood of transmitting the flu virus to others, a positive exter-nality. A confectioner’s machinery in 1879 England making it difficult for a cardiologist next door to listen to the heartbeat of his patients is an exam-ple of a negative production externality. A positive production externality is conferred by a bee-keeper located next to an apple orchard whose bees, by pollinating more flowers, increases their neighbor’s apple production. Because Externalities are external to the workings of markets, the prices at which trades occur do not reflect their additional costs (in the case of neg-ative Externalities) or benefits (in the case of positive Externalities). Con-sequently, the First Welfare Theorem typically fails, i.e., in the presence of ex ter nal i ties, the Wal ras al lo ca tion is gen er ally no longer Pareto ef fi cient. We begin by illustrating this inefficiency and then consider three “solutions” that have been suggested to mitigate these problems and that have influenced government policy towards Externalities. 262
eBook - PDFWelfare Economics
Towards a More Complete Analysis
- Y. Ng(Author)
- 2003(Publication Date)
- Palgrave Macmillan(Publisher)
7 Externality It was noted in Chapter 2 that an equilibrium situation of a perfectly competitive market economy is Pareto optimal under certain conditions. One of these conditions is the absence of (unaccounted for) external effects. However external effects are pervasive. External effects in the form of envir- onmental disruption have attracted both academic and public attention for decades (see for example Papandreou, 1994; Stavins, 2000). This chapter considers how external effects can cause non-optimality, and how this can be alleviated. But first we shall discuss the concept and classification of external effects. 7.1 The concept and classification of Externalities Obviously, for an external effect to be present there must first be an effect. Some party, K (the affecting party) must produce an effect on some other party, J (the affected party). The effect must not just be present but must also have a positive or negative welfare significance. For example if water from my neighbour’s garden hose flows into my garden, a physical effect is there. But if I do not care about it one way or the other, it cannot be said that an externality exists. Second, the affecting party is usually a person, a group of persons or something that is under the control of persons (animals, institu- tions and so on). It is possible to speak of the external effects of, say, wild animals and use this to justify certain measures against them. But the usual methods of tax/subsidy, bargaining and so on will not be applicable. The affected party is also usually a person/group of persons or something owned by persons. However if the welfare of non-human beings, such as animals, enters into our objective function, then it is quite logical to include them as possibly affected parties. The mere presence of a welfare-relevant effect by one party on another does not necessarily constitute an externality; additional conditions are needed for the effect to be considered external.
eBook - PDFProduction, Growth, and the Environment
An Economic Approach
- William L. Weber(Author)
- 2014(Publication Date)
- CRC Press(Publisher)
In contrast, when there are negative (harmful) Externalities imposed on a third party due to pro- Externalities and Common Property Resources 165 duction and consumption private individuals acting in their own self-interest will tend to overproduce and overconsume goods and services. As an example of a positive externality, suppose that you get a flu shot or some other immunization against contagious disease. If you get a flu shot not only do you have a reduced probability of getting the flu, but other people that you are in contact with them through socializing, in class, at work, etc., should also have a reduced probability of getting the flu. Your consumption of the flu shot makes you and other people better off, but very seldom will those other people compensate you for your action; nor will you tend to account for others’ well-being when deciding whether to get a flu shot. Pollution is an example of a negative externality. In the manufacturing production process, clean air and water are used up and replaced by dirty air, dirty water, and other kinds of waste. Joint production of desirable and undesirable outputs can, when charges are not imposed on the undesirable outputs, impose third party costs. When negative Externalities are present too much of the good is produced and consumed in the private market relative to the socially optimal amount. Not all pollution is bad, though, in an economic sense. Clearly, one way to reduce air pollution would be for individuals to stop driving and take up walking or riding a bike. But these kinds of actions would entail a huge change in lifestyles and well-being for many people. It might even be the case that people forced to give up travel would have less willingness to pay for environmental services like parks, recreational lakes, and hiking trails, since the absence of the automobile would limit their access to those areas.
eBook - PDFEconomics
A Contemporary Introduction
- William A. McEachern(Author)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
C H E C K P O I N T How specifically has the federal government regulated air, water, and land pollution? 17-4 Positive Externalities To this point, we have considered only negative Externalities. But Externalities are some- times positive, or beneficial. Positive Externalities occur when consumption or produc- tion benefits other consumers or other firms. For example, people who get inoculated against a contagious disease reduce their own likelihood of contracting the disease (the personal benefit), but they also reduce the risk of transmitting the disease to others Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 17 Externalities and the Environment 393 (the external benefit). Parents who don’t get their children vaccinated risk triggering an epidemic, so the vaccination decision is not simply a private matter. For example, the Centers for Disease Control and Prevention recently reported an outbreak of measles in 17 states because some children were not vaccinated. 24 Another positive externality results from education. Society as a whole receives exter- nal benefits from education because those with more education become better citizens, can read road signs, are better able to support themselves and their families, and are less likely to require public assistance or to resort to violent crime for income. Researchers found that more schooling significantly reduces the probability of incarceration. 25 Also, the higher the minimum dropout age for school, the lower the arrest rate for property and violent crimes among 16-to-18-year-olds.
eBook - PDFHow to Regulate
A Guide for Policymakers
- Thomas A. Lambert(Author)
- 2017(Publication Date)
- Cambridge University Press(Publisher)
You don’t make another patio sale for the rest of the day. You, my friend, have been the victim and the beneficiary of “Externalities.” An externality occurs when some of the cost or benefit of an activity is experi- enced by someone “external” to the activity. The annoyance and business losses you suffered because of Brookside’s raucous pool party were negative 22 Externalities – cost spillovers. So was your rent increase occasioned by the opening of the Google facility (though, as we’ll see, that was a special type of negative externality that is less troubling). The extra business you enjoyed because of your neighbor’s new planters constituted a positive externality, a benefit spillover. Your neighbor bore the full cost of providing those planters, but could not capture all the benefit – some trickled your way. symptoms/disease With most of the market failures we will consider, the adverse effects (the symptoms) and the cause of those effects (the disease) are distinct concepts. For example, with information asymmetry, the subject of Chapter 8, the primary symptom – an absence of high-quality products or services of a certain sort – is quite different than the disease – the fact that the sellers of those products and services have far more information about quality than do potential buyers. We usually have to connect a few dots to see exactly how a market failure occasions the adverse effects that result. With an externality, though, one symptom is closely related to the disease. When the externality is negative, there is an apparent injustice to the party bearing the spilled-over cost. It simply wasn’t fair, for example, for Brookside to disrupt your business with its loud pool party. When the externality is positive, the injustice is suffered by the party that created the benefit but couldn’t fully capture it. It wasn’t fair to your cafe ´ neighbor, for instance, that you should benefit from its planters even though you didn’t contribute to their creation.
eBook - ePubEnvironmental and Natural Resources Economics
Theory, Policy, and the Sustainable Society
- Steven Hackett, Sahan T. M. Dissanayake(Authors)
- 2014(Publication Date)
- Routledge(Publisher)
In principle, we can argue for government regulatory intervention in the case of pollution Externalities based on efficiency alone: resources are not efficiently allocated because too much of the good is produced when Externalities remain unresolved. There is also a fairness argument: unless we have a positive externality that requires subsidy, why should society have to absorb part of a firm’s costs? While economists generally accept the theory of Externalities, not all agree that Externalities are very large or important. Indeed, if external costs are small and insignificant, then little is lost by simply ignoring them as minor side effects of the wealth generated by markets. Measurement of damage costs must take into account the relationship between the action (e.g., pollution) and the impact (e.g., diminished human health), and between the impact and economic cost (e.g., healthcare expenditures, the value of foregone production, and the value assigned to diminished quality of life).For example, as mentioned in Chapter 1 , recent estimates by the U.S. Environmental Protection Agency (1997) indicate that the Clean Air Act of 1970 created substantial benefits in the form of avoided external costs. In particular, between 1970 and 1990 the Clean Air Act is thought to have prevented an estimated $22.2 trillion in pollution harms to human health, agriculture, and the environment in constant 1990 dollars. As will be described in detail in Chapter 6 , these benefits were substantially larger than the costs. Thus Externalities can indeed be very large and are worthy of well-designed environmental regulatory policy.The National Research Council (NRC 2009) provides damage cost estimates for various types of vehicle fuels. The NRC evaluates motor vehicle damages over four life-cycle stages: (1) vehicle operation, which results in tailpipe emissions and evaporative emissions; (2) production of feedstock, including the extraction of the resource (oil for gasoline, biomass for ethanol, or fossil fuels for electricity) and its transportation to the refinery; (3) refining or conversion of the feedstock into usable fuel and its transportation to the dispenser; and (4) manufacturing and production of the vehicle. Importantly, vehicle operation accounted in most cases for less than one-third of total damages, with other components of the life cycle contributing the rest.
eBook - PDFMicroeconomics
A Contemporary Introduction
- William A. McEachern(Author)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
C H E C K P O I N T How specifically has the federal government regulated air, water, and land pollution? 17-4 Positive Externalities To this point, we have considered only negative Externalities. But Externalities are some-times positive, or beneficial. Positive Externalities occur when consumption or produc-tion benefits other consumers or other firms. For example, people who get inoculated against a contagious disease reduce their own likelihood of contracting the disease (the personal benefit), but they also reduce the risk of transmitting the disease to others Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 17 Externalities and the Environment 393 (the external benefit). Parents who don’t get their children vaccinated risk triggering an epidemic, so the vaccination decision is not simply a private matter. For example, the Centers for Disease Control and Prevention recently reported an outbreak of measles in 17 states because some children were not vaccinated. 24 Another positive externality results from education. Society as a whole receives exter-nal benefits from education because those with more education become better citizens, can read road signs, are better able to support themselves and their families, and are less likely to require public assistance or to resort to violent crime for income. Researchers found that more schooling significantly reduces the probability of incarceration. 25 Also, the higher the minimum dropout age for school, the lower the arrest rate for property and violent crimes among 16-to-18-year-olds.
eBook - PDF- C. Gopalakrishnan(Author)
- 2000(Publication Date)
- Palgrave Macmillan(Publisher)
The legal position has also been modi- fied by statutory enactments. 53 Williams, op. cit. supra n. 49 at 242, 258. 54 Boulston v. Hardy, Cro. Eliz., 547, 548, 77 Eng. Rep. 216. 55 Williams, op. cit. supra n. 49 at 243. 56 58 Sol. J. 612 (1913–1914). 57 Williams, op. cit. supra n. 49 at 259. 58 Pigou, op. cit. supra n. 35 at 185. 59 Williams, op. cit. supra n. 49 at 244–47. 60 Pigou, op. cit. supra n. 35 at 192. 61 Id. 174–75. 62 Id. 177–83. 63 Id. 175–77. 64 Id. 192–4, 381 and Public Finance 94–100 (3d ed. 1947). The Problem of Social Cost 137 6 Externality James M. Buchanan and William C. Stubblebine Externality has been, and is, central to the neo-classical critique of market organisation. In its various forms – external economies and dis- economies, divergencies between marginal social and marginal private cost or product, spillover and neighbourhood effects, collective or public goods – externality dominates theoretical welfare economics, and, in one sense, the theory of economic policy generally. Despite this importance and emphasis, rigorous definitions of the concept itself are not readily available in the literature. As Scitovosky has noted, “defini- tions of external economies are few and unsatisfactory”. 1 The following seems typical: External effects exist in consumption whenever the shape or posi- tion of a man’s indifference curve depends on the consumption of other men. [External effects] are present whenever a firm’s production func- tion depends in some way on the amounts of the inputs or outputs of another firm. 2 It seems clear that operational and usable definitions are required. In this paper, we propose to clarify the notion of externality by defin- ing it rigorously and precisely. When this is done, several important, and often overlooked, conceptual distinctions follow more or less auto- matically.
eBook - PDF- Michael Albert, Robin Hahnel(Authors)
- 2017(Publication Date)
- Princeton University Press(Publisher)
236 The Prevalence of Externalities and Public Goods 2. There is no qualitative difference between public goods and exter- nalities and no reason to treat them differently at a theoretical level. Public goods or bads are simply Externalities whose effects are more pervasive than what convention has chosen to call an externality. Externalities are simply public goods or bads whose effects are too circumscribed to merit the label public. 3. The primary intentions of the economic actor whose decision generates external effects for others and the private or public status of that actor, are of no theoretical consequence as far as social efficiency is concerned. 4. The issue is not the characteristics of goods but the characteristics of markets, since it is the market/propertyrightsystem that establishes who gets to make what decisions. How is it that "traditional solutions" that involve a government with coercive powers might improve matters? And why have economists con- cluded that while "traditional solutions" might improve upon market allocation and voluntary association, they are all, to some extent, inevitably flawed? Here we will uncover a very peculiar lack of rigor in the analysis by traditional welfare theorists. Suppose we substitute a government for the market-property-right system of allocating resources in all cases where external effects exist and instruct the government to do so in a socially efficient manner. The goverment must decide two things: how much of each activity that generates effects external to the market decision-making process should occur, and how much to assess each citizen to defray whatever costs may arise from implementing its first decision. In language more familiar to students of public finance, the goverment must make (1) a decision about expenditures—how much to spend on the provision of different public goods, and (2) a decision about taxation—how to collect the revenues necessary to cover the expenditures.
eBook - PDFEnvironmental Economics
Theory and Policy
- Alfred Endres, Iain L. Fraser(Authors)
- 2010(Publication Date)
- Cambridge University Press(Publisher)
However, allowing such a right would go beyond the framework of the “law of the jungle” as an allocation mechanism. Where it is claimed in the text that under this law the utilization plans of the producers of the Externalities would prevail, we are ignoring the possibility that those damaged prevent the emissions by force. 3 Cf. chapter A in part two. 4 Cf. section B.III in part three. The Internalization of Externalities as a Central Theme of Environmental Policy 3 Many economists are particularly fascinated by comparing the actual result reached by a particular allocation mechanism with a “socially optimal” result. Of course, it is necessary for this undertaking to develop a criterion of social optimality. If an analysis of the market mechanism finds that the market outcome (“equilibrium”) departs from the optimum, this gives the economist occasion to ponder possible correction mechanisms. 5 We show in detail that the existence of environmental problems (in economic terminology, “Externalities”) establishes a divergence between market equilibrium and optimum. The “internalization of Externalities” treated in part two of this book is nothing but an attempt to make economic policy corrections to the market mechanism with the aim of bringing equilibrium and optimum together. Of course, the demand that politics should bring about an optimum position is – in the sphere of environmental policy as in any other sphere – for various reasons too ambitious. Nonetheless, it is worthwhile to operationalize the concept of optimality and discover structural causes of market mechanism failures by comparing the market equilibrium with the optimum. Even if, in reality, the optimum will perhaps never be reached, we might still provide guidance to environmental policy, which all too often has its view of what direction to take confused (comprehensible as this may be) by the undergrowth of everyday problems.
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