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In economics, an externality is an impact (positive or negative) on anyone not party to a given economic transaction. ‹ The template below is being considered for deletion. ...

An externality occurs when a decision causes costs or benefits to third party stakeholders, often, although not necessarily, from the use of a public good. In other words, the participants in an economic transaction do not necessarily bear all of the costs or reap all of the benefits of the transaction. For example, manufacturing that causes air pollution imposes costs on others when making use of public air. In a competitive market, this means too much or too little of the good may be produced and consumed in terms of overall cost or benefit to society, depending on incentives at the margin and strategic behavior. A stakeholder is a person who holds money or other property while its owner is being determined. ... In economics, a public good is a good that is non-rivalrous and non-excludable. ... Air pollution is a chemical, particulate matter, or biological agent that modifies the natural characteristics of the atmosphere. ...

In the absence of significant externalities, parties to an economic transaction are assumed to benefit, improving the overall welfare of society. If third parties benefit substantially, such as in areas of education or safety, the good may be under-provided (or under-consumed); if costs to the public exceed costs to the economic decision makers, such as in pollution, the good may be over-provided, in terms of overall benefit or cost to society. Here, overall benefit and cost to society are defined as the collective economic utility for society. For other uses, see Safety (disambiguation). ... It has been suggested that Pollutant be merged into this article or section. ... In economics, utility is a measure of the relative happiness or satisfaction (gratification) gained. ...



External costs and benefits
External costs and benefits

Economic theory considers any voluntary exchange to be mutually beneficial to both parties, for example a buyer and seller. Any exchange, however, can result in additional positive or negative effects on third parties. Those who suffer from external costs do so involuntarily, while those who enjoy external benefits do so at no cost. The left side of the chart (at right) shows externalities associated with consumption (such as the air pollution caused by driving), while the right side shows production externalities (such as water pollution from a car factory). Image File history File links This is a lossless scalable vector image. ... Image File history File links This is a lossless scalable vector image. ...

From the perspective of a social planner or welfare economist, negative externalities result in an outcome that is not socially optimal. From the perspective of those affected, a negative externality is a problem (pollution from a factory), or a gain (honey bees that pollinate the garden). In the first case, the person who is affected by the negative externality in the case of air pollution will see it as lowered utility: either subjective displeasure or potentially explicit costs, such as higher medical expenses. The externality may even be seen as trespassing on their lungs, violating their property rights. Thus, an external cost may pose an ethical or political problem. Alternatively, it might be seen as a case of poorly-defined property rights, as with, for example, pollution of bodies of water that may belong to no-one (either figuratively, in the case of publicly-owned, or literally, in some countries and/or legal traditions). In welfare economics, a social planner is a decision-maker who attempts to achieve the best result for all parties involved. ... Welfare economics is a branch of economics that uses microeconomic techniques to simultaneously determine the allocational efficiency of a macroeconomy and the income distribution associated with it. ... In law, trespass can be: the criminal act of going into somebody else’s land or property without permission; it is also a civil law tort that may be a valid cause of action to seek judicial relief and possibly damages through a lawsuit. ... Human respiratory system The lungs flank the heart and great vessels in the chest cavity. ... Ethics is a general term for what is often described as the science (study) of morality. In philosophy, ethical behavior is that which is good or right. ... Politics is the process by which decisions are made within groups. ... This page deals with property as ownership rights. ...

An external benefit, on the other hand, may increase the utility of third parties at no cost to them, which could be called "free lunch". Since the collective utility of society is improved but the direct participants have no way of monetizing the benefit, less of the good will be produced or consumed than would be optimal for society as a whole. Goods with positive externalities include education (believed to increase overall productivity and therefore well-being) and health care (which may reduce the health risks and costs for third parties). Positive externalities are frequently associated with the free rider problem. For example, individuals who are vaccinated reduce the risk of contracting the relevant disease for all others around them, and at high levels of vaccination, society may receive large health and welfare benefits; but any one individual can refuse vaccination, still avoiding the disease by "free riding" on the costs borne by others. TANSTAAFL is an acronym for the adage There Aint No Such Thing As A Free Lunch, popularized by science fiction writer Robert A. Heinlein and promulgated in his 1966 novel The Moon Is a Harsh Mistress, which deals with a libertarian utopia. ... In economics and political science, free riders are actors who consume more than their fair share of a resource, or shoulder less than a fair share of the costs of its production. ...

There are a number of potential means of improving overall social utility when externalities are involved. The market-driven approach to correcting externalities is to "internalize" third party costs and benefits, for example, by requiring a polluter to repair any damage caused. In many cases, however, internalizing costs or benefits is not feasible or the true value cannot be determined.

The value of the effects of the externality are difficult to quantify because they reflect the ethical views and preferences of the entire population. It may not be clear whose preferences are most important, interests may conflict, the value of externalities may be difficult to determine, and all parties involved may attempt to influence the policy responses to their own benefit. Because it may not be feasible to monetize the costs and benefits, another method is needed to either impose solutions or aggregate the choices of society, when externalities are significant. This may be through some form of representative democracy or other means. Political economy is, in broad terms, the study of the means and results of aggregating those choices and benefits that are not limited to purely private transactions. Representative democracy is a form of government founded on the principles of popular sovereignty by the peoples representatives. ... The Politics series Politics Portal This box:      Political economy was the original term for the study of production, the acts of buying and selling, and their relationships to laws, customs and government. ...

Laissez-faire economists such as Friedrich Hayek and Milton Friedman sometimes refer to externalities as "neighborhood effects" or "spillovers", although externalities are not necessarily minor or localized. Laissez-faire is short for laissez faire, laissez passer, a French phrase meaning to let things alone, let them pass. First used by the eighteenth century Physiocrats as an injunction against government interference with trade, it is now used as a synonym for strict free market economics. ... Friedrich August von Hayek, CH (May 8, 1899 in Vienna – March 23, 1992 in Freiburg) was an Austrian-born British economist and political philosopher known for his defense of liberal democracy and free-market capitalism against socialist and collectivist thought in the mid-20th century. ... Milton Friedman (July 31, 1912 – November 16, 2006) was an American Nobel Laureate economist and public intellectual. ... This article needs to be cleaned up to conform to a higher standard of quality. ...

Outside the broadly-defined liberal political tradition, Marxists see externalities of all kinds, including pecuniary ones, as ubiquitous, being the rule rather than the exception. Production is socialized or totally interdependent. On the other hand, under capitalism, property rights, the appropriation of income, and the making of economic decisions are largely individualized. In order to solve this contradiction between socialized production and individual decision-making, Marxists often call for democratic economic planning, as a key part of socialism (cf. Frederick Engels, "Socialism: Utopian and Scientific"). Liberalism is an ideology, philosophical view, and political tradition which holds that liberty is the primary political value. ... Marxism is both the theory and the political practice (that is, the praxis) derived from the work of Karl Marx and Friedrich Engels. ... An example of Money. ... For other uses, see Capitalism (disambiguation). ... Broadly speaking, a contradiction is an incompatibility between two or more statements, ideas, or actions. ... Socialism refers to a broad array of doctrines or political movements that envisage a socio-economic system in which property and the distribution of wealth are subjfuck grapesect to control by the community[1] for the purposes of increasing social and economic equality and cooperation. ...

Supply and demand diagram

The usual economic analysis of externalities can be illustrated using a standard supply and demand diagram if the externality can be monetized and valued in terms of money. An extra supply or demand curve is added, as in the diagrams below. One of the curves is the private cost that consumers pay as individuals for additional quantities of the good, which in competitive markets, is the marginal private cost. The other curve is the true cost that society as a whole pays for production and consumption of increased production the good, or the marginal social cost. The supply and demand model describes how prices vary as a result of a balance between product availability at each price (supply) and the desires of those with purchasing power at each price (demand). ... For other uses, see Money (disambiguation). ...

Similarly there might be two curves for the demand or benefit of the good. The social demand curve would reflect the benefit to society as a whole, while the normal demand curve reflects the benefit to consumers as individuals and is reflected as effective demand in the market. Effective demand (in macroeconomics often seen as synonymous with aggregate demand), refers to the very simple economic idea that says that its not enough to want something such as food or luxuries. ...



Many negative externalities (external cost or external diseconomy) are related to the environmental consequences of production and use. The article on environmental economics also addresses externalities and how they may be addressed in the context of environmental issues. Environmental economics is a subfield of economics concerned with environmental issues (other usages of the term are not uncommon). ...

  • Pollution of any form that causes nuisance or harm to others.
  • Individuals collectively choose to use a public transportation resource (such as roads), imposing congestion costs on all other users.
  • A business may purposely underfund one part of their business, such as their pension funds, in order to push the costs onto someone else, creating an externality. Here, the "cost" is that of providing minimum social welfare or retirement income; economists more frequently attribute this problem to the category of moral hazards.
  • Consumption by one consumer causes prices to rise and therefore makes other consumers worse off, perhaps by reducing their consumption. These effects are sometimes called "pecuniary externalities". Many economists do not accept the concept of pecuniary externalities, attributing such problems to anti-competitive behavior, monopoly power, or other definitions of market failures.
  • Accidents caused by alcohol abuse or any other human action
  • Commonized costs of declining health and vitality caused by smoking and/or alcohol abuse. Here, the "cost" is that of providing minimum social welfare. Economists more frequently attribute this problem to the category of moral hazards.

In these situations the marginal social benefit of consumption is less than the marginal private benefit of consumption. (i.e. SMB < PMB) This leads to the good or service being over-consumed relative to the social optimum. Without intervention the good or service will be under-priced and the negative externalities will not be taken into account. This article is about gathering crops. ... Fishing is the activity of hunting for fish by hooking, trapping, or gathering. ... Animated map exhibiting the worlds oceanic waters. ... × The Traffic Light colour convention, showing the concept of Harvest Control Rule (HCR), specifying when a rebuilding plan is mandatory in terms of precautionary and limit reference points for spawning biomass and fishing mortality rate. ... A Common Property Resource or Common Pool Resource (CPR) is produced by a sufficiently large resource system that makes it costly but not impossible to exclude potential beneficiaries. ... The Tragedy of the Commons is a type of social trap, often economic, that involves a conflict over resources between individual interests and the common good. ... In economics, a business is a legally-recognized organizational entity existing within an economically free country designed to sell goods and/or services to consumers, usually in an effort to generate profit. ... This article does not cite any references or sources. ... This section is studied by Argagui monopoli In law and economics, moral hazard is the name given to the risk that one party to a contract can change their behaviour to the detriment of the other party once the contract has been concluded. ... A pecuniary externality is an externality which operates through prices rather than through real resource effects. ... This section is studied by Argagui monopoli In law and economics, moral hazard is the name given to the risk that one party to a contract can change their behaviour to the detriment of the other party once the contract has been concluded. ...


Examples of positive externalities (beneficial externality, external benefit, external economy, or Merit goods) include: A merit good is defined in economics as a good that is under consumed if provided by the market mechanism because individuals typically consider how the good benefits them as individuals rather than the benefits that consumption generates for others in society. ...

  • A beekeeper keeps the bees for their honey. A side effect or externality associated with his activity is the pollination of surrounding crops by the bees. The value generated by the pollination may be more important than the value of the harvested honey.
  • An individual planting an attractive garden in front of his house may provide benefits to others living in the area, and even financial benefits in the form of increased property values for all property owners.
  • An individual buying a picture-phone for the first time will increase the usefulness of such phones to people who might want to call him or her. When each new user of a product increases the value of the same product owned by others, the phenomenon is called a network externality or a network effect. Network externalities often have "tipping points" where, quite suddenly, the product reaches general acceptance and near-universal usage.
  • Inventions and information - once an invention (or most other forms of practical information) is discovered or made more easily accessible, others benefit by exploiting the invention or information. Copyright and intellectual property law are mechanisms to allow the inventor or creator to benefit from a temporary, state-protected monopoly in return for "sharing" the information through publication or other means.
  • Flu vaccinations of school children - the children themselves are unlikely to be greatly harmed by the flu, but vaccination of school children may often be the most efficient way to protect the vulnerable elderly.
  • Sometimes the better part of a benefit from a good comes from having the option to buy something rather than actually having to buy it. A private fire department that only charged people that had a fire, would arguably provide a positive externality at the expense of an unlucky few. Some form of insurance could be a solution in such cases, as long as people can accurately evaluate the benefit they have from the option.

As noted, externalities (or proposed solutions to externalities) may also imply political conflicts, rancorous lawsuits, and the like. This may make the problem of externalities too complex for the concept of Pareto optimality to handle. Similarly, if too many positive externalities fall outside the participants in a transaction, there will be too little incentive on parties to participate in activities that lead to the positive externalities. A beekeeper is a person who keeps honey bees for the purposes of securing commodities such as honey, beeswax, pollen; pollinating fruits and vegetables; raising queens and bees for sale to other farmers; and/or for purposes satisfying natural scientific curiosity. ... Families Andrenidae Anthophoridae Apidae Colletidae Ctenoplectridae Halictidae Heterogynaidae Megachilidae Melittidae Oxaeidae Sphecidae Stenotritidae This article is about the insect. ... For other uses, see Honey (disambiguation). ... Carpenter bee with pollen collected from Night-blooming cereus Pollination is an important step in the reproduction of seed plants: the transfer of pollen grains (male gametes) to the plant carpel, the structure that contains the ovule (female gamete). ... The network effect causes a good or service to have a value to a potential customer dependent on the number of customers already owning that good or using that service. ... A network effect is a characteristic that causes a good or service to have a value to a potential customer which depends on the number of other customers who own the good or are users of the service. ... In music, an invention is a short composition with two or three part counterpoint. ... Not to be confused with copywriting. ... For the 2006 film, see Intellectual Property (film). ... This article is about the economics of markets dominated by a single seller. ... Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of a contingent loss. ... Pareto efficiency, or Pareto optimality, is a central concept in game theory with broad applications in economics, engineering and the social sciences. ...

The graph below shows the effects of a positive or beneficial externality. For example, the industry supplying smallpox vaccinations is assumed to be selling in a competitive market. The marginal private benefit of getting the vaccination is less than the marginal social or public benefit by the amount of the external benefit (for example, society as a whole is increasingly protected from smallpox by each vaccination, including those who refuse to participate). This marginal external benefit of getting a smallpox shot is represented by the vertical distance between the two demand curves. Assume there are no external costs, so that social cost equals individual cost.

Supply & Demand with external benefits
Supply & Demand with external benefits

If consumers only take into account their own private benefits from getting vaccinations, the market will end up at price Pp and quantity Qp as before, instead of the more efficient price Ps and quantity Qs. These latter again reflect the idea that the marginal social benefit should equal the marginal social cost, i.e., that production should be increased as long as the marginal social benefit exceeds the marginal social cost. The result in an unfettered market is inefficient since at the quantity Qp, the social benefit is greater than the societal cost, so society as a whole would be better off if more goods had been produced. The problem is that people are buying too few vaccinations. External benefits with S&D -- I drew it myself. ... External benefits with S&D -- I drew it myself. ... A free market is an idealized market, where all economic decisions and actions by individuals regarding transfer of money, goods, and services are voluntary, and are therefore devoid of coercion and theft (some definitions of coercion are inclusive of theft). Colloquially and loosely, a free market economy is an economy... The term inefficiency has several meanings depending on the context in which its used: Economic inefficiency refers to a situation where we could be doing a better job, i. ...

The issue of external benefits is related to that of public goods, which are goods where it is difficult if not impossible to exclude people from benefits. The production of a public good has beneficial externalities for all, or almost all, of the public. As with external costs, there is a problem here of societal communication and coordination to balance benefits and costs. This also implies that pollution is not something solved by competitive markets. The government may have to step in with a collective solution, such as subsidizing or legally requiring vaccine use. If the government does this, the good is called a merit good. In economics, a public good is one that cannot or will not be produced for individual profit, since it is difficult to get people to pay for its large beneficial externalities. ... A merit good is defined in economics as a good that is under consumed if provided by the market mechanism because individuals typically consider how the good benefits them as individuals rather than the benefits that consumption generates for others in society. ...


Positional externalities refer to a special type of externality that depends on the relative rankings of actors in a situation. Because every actor is attempting to "one up" other actors, the consequences are unintended and economically inefficient.

An example of this would be working overtime at a job to look better than other employees. Because every employee wishes to look better than other employees, so as to get a raise or promotion, if one employee starts to work overtime then all employees must. And as each successive employee works more and more overtime, the externality gets larger and larger. No employee wants to work overtime, but each feels that he must in order to prevent being left behind.

Another example is the buying of jewelry for another person. In order for Person A to show that he values his spouse more than Person B values his spouse, Person A must buy his spouse more expensive jewelry than Person B buys. As in the first example, the cycle continues to get worse, because every actor positions himself/herself in relation to the other actors.

One solution to such externalities is regulations imposed by an outside authority. For the first example, the government might pass a law against working overtime. Thus every employee can go home and spend time at home with the family, what he/she really wants, and not worry about losing prestige at work.

Coase theorem

Main article: Coase theorem

Ronald Coase argued that individuals could organize bargains so as to bring about an efficient outcome and eliminate externalities without government intervention. The government should restrict its role to facilitating bargaining among the affected groups or individuals and to enforcing any contracts that result. This result, often known as the Coase Theorem, requires that This article or section is in need of attention from an expert on the subject. ... Ronald Harry Coase (b. ...

  • Property rights are well defined
  • People act rationally
  • Transaction costs are minimal

If all three of these apply, individuals will bargain to solve the problem of externalities.

Thus, this theorem does not apply to the steel industry case discussed above. For example, with a steel factory that trespasses on the lungs of a large number of individuals with pollution, it is difficult if not impossible for any one person to negotiate with the producer, and there are large transaction costs. Hence the most common approach may be to regulate the firm (by imposing limits on the amount of pollution considered "acceptable") while paying for the regulation and enforcement with taxes.-1...

The case of the vaccinations also does not fit with the Coase Theorem. The firms of the vaccination industry would have to get together to bribe large numbers of people to have their shots. Individual firms would be tempted to "free ride" and not pay the cost of these bribes. The property rights involved are not well defined.

This does not say that the Coase theorem is irrelevant. For example, if a logger is planning to clear-cut a forest in a way that has a negative impact on a nearby resort, the resort-owner and the logger could theoretically get together to agree to a deal. For example, the resort-owner could pay the logger not to clear-cut -- or could buy the forest. The most problematic situation, from Coase's perspective, occurs when the forest literally does not belong to anyone; the question of "who" owns the forest is not important, as any specific owner will have an interest in coming to an agreement with the resort owner (if such an agreement is mutually beneficial). Logging is the process in which trees are cut down usually as part of a timber harvest which is good for the environment. ... This article is about a community of trees. ... Resorts combine a hotel and a variety of recreations, such as swimming pools. ...

Also, the central government may not be needed. Traditional ways of life may have evolved as ways to deal with external costs and benefits. Alternatively, democratically-run communities can agree to deal with these costs and benefits in an amicable way.

See also

A Pigovian tax is a tax levied to correct the negative externalities of an activity. ...


  • Defintion
  • Pigou, A.C. (1920). Economics of Welfare. Macmillan and Co.. 
  • Tullock, G. (2005). Public Goods, Redistribution and Rent Seeking. Edward Elgar Publishing, Inc.. ISBN 1-84376-637-X. 

  Results from FactBites:
Externality: A Glossary of Political Economy Terms - Dr. Paul M. Johnson (1167 words)
An "external diseconomy," "external cost" or "negative externality" results when part of the cost of producing a good or service is born by a firm or household other than the producer or purchaser.
Externalities of either the "positive" or the "negative" sort create a problem for the effective functioning of the market to maximize the total utility of the society.
subsidy approach to remedying externalities problems is, of course, that it may well be impossible or prohibitively expensive for the government to determine the size of the external costs or benefits involved and hence to determine even approximately what an appropriate tax or subsidy rate would be.
Externality - Wikipedia, the free encyclopedia (2665 words)
An externality occurs when a decision causes costs or benefits to stakeholders other than the person making the decision, often, though not necessarily, from the use of a public good (for example, a decision which results in pollution of the atmosphere would involve an externality).
From the perspective of anybody affected by the externality, it is either a negative factor in their lives, as with obnoxious smell or pollution or a boon, as with the other's pretty clothes.
A side effect or externality associated with his activity is the pollination of the surrounding crops by the bees.
  More results at FactBites »



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