An externality is a cost or benefit that one person creates but affects someone else financially. There are two types of externalities: negative and positive. A negative externality happens when one person imposes a cost on another without compensation. In contrast, a positive externality occurs when one person gains an indirect benefit from the actions of another.
Externalities can arise from how a good or service is made or used. The costs and benefits can be private, affecting individuals or organizations, or social, impacting society overall.
Learn more about Externality
Externalities happen in an economy when the production or use of a certain good or service affects someone who is not directly involved in that process.
Most externalities are seen as technical externalities. These technical externalities influence the consumption and production options of unrelated third parties, but the price of the good or service does not reflect these external effects. This leads to a difference between the benefits or costs for individuals and the overall benefits or costs for society.
Individual or organizational actions can lead to personal benefits but may harm the larger economy. Many economists view technical externalities as failures in the market, which is why there are calls for government action to manage negative externalities through taxes and regulations.
In the past, local governments and affected individuals handled externalities. For example, towns had to cover the costs of pollution caused by nearby factories, while residents dealt with their own healthcare expenses due to that pollution. After the late 1990s, laws were created to make producers responsible for the costs of externalities.
Type of Externalities
Externalities can be divided into two main types. First, they can be seen as either beneficial or harmful, depending on whether the side effects help or hurt others. These are called positive or negative externalities. Second, externalities can be categorized based on their origin, usually as production or consumption externalities.
- Negative Externalities
- Positive Externalities
- Production Externalities
- Consumption Externalities
Examples of Externalities
Many countries have carbon credits that people can buy to reduce their emissions. The prices of these carbon credits are based on the market and can change often, depending on how much demand there is from other buyers.
The Regional Greenhouse Gas Initiative (RGGI) is a program in the United States that includes 12 states, including California and 11 from the Northeast. It is a mandatory cap-and-trade program designed to limit carbon dioxide emissions from the power sector.
Different agencies have a set limit on their emissions, but they can trade allowances to adjust their limits. Agencies that find it hard to manage their pollution may need to buy extra credits to raise their limits. Conversely, agencies that successfully reduce their emissions can sell some of their allowance to regain funds spent on managing their pollution.
Conclusion
An externality is a result of a main activity. This effect can be positive or negative and can come from either making something or using it. Many externalities are linked to the environment because of how businesses and individuals act. However, there are various ways that governments, companies, and individuals can help prevent and fix these externalities.