Externalities are costs or benefits associated with consumption or production that are not incurred by the consumer or producer and are therefore not reflected in market prices. The cost or benefit of an externality remains external when falling to parties other than the buyer or seller. Prior to beginning work on this discussion forum, read Chapter 6 of the textbook.
Respond to the following:
Describe some differences between a positive externality and a negative externality.
Provide one example of a positive externality and a negative externality, respectively. Explain your reasoning.
How could you solve your examples of externalities to attain market efficiency?
Does the government need to intervene with externalities to effect market efficiency?
Your initial post should be a minimum of 300 words.
Describe some differences between a positive externality and a negative externality.
In an efficient market, there is an optimal production of goods so that all benefits and costs of the production and consumption process are incurred by the people involved in the transaction. However, market failures often lead to negative and positive externalities.
A positive externality is a benefit that spills over to third parties in society during the production or consumption of a product. On the other hand, a negative externality occurs when the production or consumption of a product leads to costs for third parties.
Provide one example of a positive externality and a negative externality, respectively. Explain your reasoning.
A good example of a positive externality occurs when a school enrolls an individual to their system, the society benefits from the education of that individual. A person who attends a school develops knowledge and skills that helps them to work and deliver services to his community. Thus, the individual’s education is an example of positive externality because society benefits indirectly from the education offered by the institution where the individual was educated.
Pollution is one of the most cited examples of negative externalities. For example, if when a manufacturing company releases waste water into a river, the water becomes polluted and affects water animals and communities living downstream. This is a negative externality because the actions of the firm when producing its goods leads to negative effects for society.
How could you solve your examples of externalities to attain market efficiency?
From the examples above, the negative externalities can be solved to achieve market efficiency by internalizing the externalities. Internalizing externalities occurs when the costs of negative externalities are borne by the company. For example, a company should compensate communities for the damage that it causes when it releases wastes into water bodies. The firm can also use recycling method to avoid releasing waste water into the environment.
Does the government need to intervene with externalities to effect market efficiency?
The government needs to intervene when a company is not able to internalize its negative externalities. The government can use three methods: subsidies, taxation, and regulation. Subsidies are offered to companies that have effectively limited negative externalities. Taxation is implemented by taxing a company for every unit of costs incurred as a result of negative externalities. Lastly, the government can develop regulations that prohibit activities leading to negative externalities, with serious penalties for non-compliance.
