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Externalities Economics Examples

Externalities

Externality is a concept of economics which is a positive or negative impact on the third party which is not directly involved in the economic transaction but affected by that particular transaction. Mainly, both the consumers and producers in a market do not bear all the costs or also not bear all the benefits of any economic transaction. Like most of the times manufacturing causes pollution which imposes costs on people living near by, and in term of benefit sowing forests will improve the quality of water and atmosphere.

 

Few moderate economists like Milton Friedman and Friedrich Hayek explain externalities like "spillovers" or "neighborhood effects", according to them externalities are mostly minor and limited to a small area.

 

In the long run competitive markets, costs and benefits are also consumed by the producer like installing filter plants to reduce the pollution and educational and other public activities by the market participants and government respectively.  

 

External costs and benefits illustration:

 

There are numberless types of external benefits and costs some of them are mentioned as follow: a negative externality cost of air pollution which causes higher medical expenses to lungs diseases.  

 

Negative externalities:

 

Poorly defining the property rights is another external cost. Violating their property rights is another cost carried by the third party which creases ethical and social problems. Climate change caused by burning fossil fuels causes global warming, Water pollution by spoil plants, affects animals and humans. Use of alcoholic drinks leads to driving accidents and which injures the people on road and other drivers.  

 

 

Positive externalities:

 

Examples of external benefits include education, health care and law enforcement by government which is consumed by every person of society without bearing any cost.

Making garden in front of the house and plant some attractive plants may benefit to the people living and passing through the area and may also increase the property values surrounding houses owners. Building some commercial plazas may also increase the property values of residential area home buildings. Making markets and parks around the residential areas may also increase the value of near by properties. A person who buy a VCD player or play station will benefit to the rest of the family to get entertain with the equipments. 

 

 

In general an externality cost can be a huge like political conflicts; revengeful lawsuits etc or it can also be a minor one. In the same way there are numberless external benefits which have a too little incentive to the third parties.

 

 

 
Economic rationalizations of externalities:

 

A general justification of any economic analysis is explained by the supply and demand curves diagrams. To explain the externality an extra supply or demand curve is added, as shown in the below diagrams Here in this diagram One curve is the marginal private cost which customers pays as an individual for added quantities of the product. The other curve is the real cost shows the cost paid by the society as a whole for manufacturing which increases the consumption to manufacture the product called  marginal social cost curve. In the same way there are two curves for the demand. The social demand curve shows the benefit to society as a whole.

 

Negative externalities

 

The graph given under shows the effect of external cost effect or negative externality. In the below graph an iron industry is selling its product in a competitive market prior to pollution law was in action by the government. In this condition the marginal private cost is lower than marginal social cost with the difference of external cost like air and water pollution costs, which is shown by the vertical distance between both supply curves. Assuming, there is not any external benefits, resulting social benefit equals private benefit.                                                                                                           

 

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The diagram confirms that negative externalities causes inefficiencies and becomes a source of market failure.  

Positive externalities

The graph for positive externality shows the effects benefits according form the business to the third parties or external people. The graph given under shows positive affect of a pharmaceuticals industry supplying medicine for different diseases is selling in competitive market. The marginal private benefit of using the medicines is less than the marginal social or public benefit by the amount of the external benefit for example; people as a whole are progressively more protected from diseases by every amount of increasing production of medicine. This marginal external benefit of getting diseases shot by the medicine produced is shown by the vertical space between the two demand curves. It is assumed that there is not any external cost so that social cost equals private or cost.

 

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Social equilibrium is the ideal situation for economy. The diagram confirms that positive externalities doesn’t cause inefficiencies or become source of market failure.

 

 

There are almost four types major of solutions for the problem of externalities given as under:

 

Criminalization:

 

The first type of problem solution is making and enforcement of laws by the government in an effective way. These laws are to protect the crime like prostitution, commercial fraud, addictive drugs, and other types of public health and environmental laws.

 

Civil Tort law:

 

 This solution is protection against the minor bad habits by the people like class action against smoker, a variety of product liability suits.

 

Government provision:

 

 In this solution government provide public benefits to give extra benefits and compensation against the external costs incurred by the society in term of lighthouses, education, and national defense programs.

 

Taxes or subsidies:

 

Taxes are the most efficient and desirable solution for the externalities problems. Taxes are imposed to redress potential economic injustices and imbalances. Subsidies are given to the firms to take self actions against the economic injustices and to create external benefits to society by the firms. It is considered the most efficient method to resolve externalities problem.

 

Conclusion:

 

As discussed throughout the report that externalities are the costs or benefits to the society (Third party) by the result of economic transaction. After analyzing the graphs and rest of the report it is very clear that negative externalities are the cause of inefficiency and sources of business failure and positive externalities are the benefits and often compensation for the negative externalities. 

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