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Questions and Answers
What is an externality in economics?
What is an externality in economics?
Which of the following is an example of a positive externality?
Which of the following is an example of a positive externality?
What is a characteristic of externalities?
What is a characteristic of externalities?
What can occur when there is a negative externality?
What can occur when there is a negative externality?
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What is a way to correct externalities?
What is a way to correct externalities?
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What is an example of a negative externality?
What is an example of a negative externality?
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What can occur when there is a positive externality?
What can occur when there is a positive externality?
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Why do externalities lead to market failures?
Why do externalities lead to market failures?
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Study Notes
Definition of Externalities
- An externality is a consequence of an economic activity that affects third parties, either positively or negatively, who are not directly involved in the market transaction.
- Externalities can arise from both production and consumption activities.
Types of Externalities
-
Positive externality: a beneficial effect on third parties, e.g.:
- A beekeeper's bees pollinate neighboring crops, increasing their yield.
- A homeowner's beautiful garden increases the value of neighboring properties.
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Negative externality: a harmful effect on third parties, e.g.:
- A factory's pollution affects the health of nearby residents.
- A farmer's use of pesticides contaminates the water supply.
Characteristics of Externalities
- Unpriced: externalities are not reflected in the market price of the good or service.
- Non-rivalrous: the consumption of the externality by one person does not reduce its availability to others.
- Non-excludable: it is difficult or impossible to exclude others from consuming the externality.
Effects of Externalities on Market Outcomes
- Overproduction: negative externalities can lead to overproduction, as the producer does not bear the full cost of the externality.
- Underproduction: positive externalities can lead to underproduction, as the producer does not capture the full benefit of the externality.
Correcting Externalities
- Government intervention: regulation, taxation, or subsidy can be used to internalize the externality.
- Private solutions: negotiation, contracting, or litigation between affected parties can also be used to internalize the externality.
Definition of Externalities
- An externality is a consequence of an economic activity that affects third parties, either positively or negatively, who are not directly involved in the market transaction.
- Externalities can arise from both production and consumption activities.
Types of Externalities
- Positive externality: a beneficial effect on third parties, e.g., beekeeper's bees pollinate neighboring crops, increasing their yield, and a homeowner's beautiful garden increases the value of neighboring properties.
- Negative externality: a harmful effect on third parties, e.g., a factory's pollution affects the health of nearby residents, and a farmer's use of pesticides contaminates the water supply.
Characteristics of Externalities
- Unpriced: externalities are not reflected in the market price of the good or service.
- Non-rivalrous: the consumption of the externality by one person does not reduce its availability to others.
- Non-excludable: it is difficult or impossible to exclude others from consuming the externality.
Effects of Externalities on Market Outcomes
- Overproduction: negative externalities can lead to overproduction, as the producer does not bear the full cost of the externality.
- Underproduction: positive externalities can lead to underproduction, as the producer does not capture the full benefit of the externality.
Correcting Externalities
- Government intervention: regulation, taxation, or subsidy can be used to internalize the externality.
- Private solutions: negotiation, contracting, or litigation between affected parties can also be used to internalize the externality.
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Description
Learn about externalities in economics, including their definition, types, and examples. Understand how economic activities can affect third parties, both positively and negatively.
