What are Externalities?

//What are Externalities?
What are Externalities? 2017-10-04T08:17:57+00:00

Definition: Externalities are the positive or negative economic impact of consuming or producing a good on a third party who isn’t connected to the good, service, or transaction. In other words, they are unforeseen consequences to economic activities.

What Does Externalities Mean?

What is the definition of externalities? Generally, the social benefit should be greater than the private benefit so that society protects its members and is productive. When the production or the consumption of a good or a service proves beneficial to a third party, then it is a positive externality.

Conversely, when the production or the consumption of a good or a service is detrimental to a third party, then it is a negative externality. For example, a farmer that cultivates oranges is a positive externality because he provides society with healthy products. Conversely, someone who is smoking in a closed area is a negative externality because he may cause cancer to other people.

Let’s look at an example.

Example

Contemporary society suffers from crime, drug use, and vandalism. These are examples of negative externalities as they harm the public good. However, by building new homes to foster the homeless people, these social problems may be anticipated to a certain extent. Therefore, if the social benefit is greater than the private benefit, the outcome for the society is positive.

Furthermore, modern buildings have improved insulation, thereby lowering the cost of heating. Also, new buildings are following the contemporary environmental standards that require the building to be clean, without damp, and with a high level of sanitation. Therefore, as the social benefit is greater than the private benefit, the outcome for the society is positive.

So, if building new houses can create positive externalities, the social benefit contributes to social efficiency. In the cases that social efficiency is at stake, the government may intervene to encourage the creation of positive externalities through the production or consumption of certain goods or services. A typical example is the government intervention in the UK for the clearing of slums and their replacement with affordable homes in 2010.

Summary Definition

Define Externalities: Externality means the actions of a group of people having a positive or a negative impact on a third party.