What are Externalities?

An externality is any positive or negative outcome of an economic activity that affects the population that does not have any stake in business or industry. For example, some economic activities may emit toxic pollution and waste materials that may affect health of residents of that locality. This is a negative externality. A Little More on Externalities Externalities often occur when an industry or business activities affect those who are not related to production or consumption of goods and services. It may include pollution or waste materials that affect public health. This is one of the reasons that government becomes more active in regulating the business to restrain negative externalities.

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Externalities Can be Positive or Negative

Most often, externalities are negative in how the affect the public. For example, waste materials or emission of pollution from industry are negative externalities. Further, a business may adopt the latest technology to cut the cost of production to realize more profits. The business may realize greater gains by expanding its production and sales, but it can result in higher social and public cost. Some business activities may result in positive externalities as well. As new technologies are introduced, the business may increase profit without affecting the population. The is normally done by focusing on Research and Development (R&D) and incorporating corporate values. Resultantly, the productivity can be improved without affecting nearby population.

How to Overcome Externalities: Possible Solutions

There are several solutions to problems arises from externalities:

• Taxes - The government may impose Pigovian tax (associated with economist Arthur C. Pigou) which imposes equal tax to the value of negative externality. These taxes significantly discourage business to spread negative externalities.
• Regulations - The Government may impose more regulations on the business to overcome the negative externalities.

Related Topics

• Market Competition and Innovation
• New Technology and Positive Externalities

• Externality
• Network Externality
• Pigovian Tax
• Coase Theorem
• Agglomeration Diseconomies

• Education - Private and Social Rate of Return
• Government Approaches to Encouraging Innovation
• Public Good
• Public, Private, Club, Common Goods
• Excludable and Rivalrous Goods
• What is the Free Rider Problem for Public Goods?
• Free Rider
• Social Loafing
• Role of Government in Paying for Public Goods
• What is the Tragedy of Commons for Common Resources?
• Income Inequality
• Poverty Line?
• Poverty Trap
• Public Safety Net
• Measuring Income Inequality
• Lorenz Curve
• Ladder of Opportunity
• Tradeoff between Incentives and Income Equality