The concept of externalities was defined by Hopt (2013) as either the positive or negative consequences of the outcome of an economic activity transferred to an unrelated third party. Hopt (2013) argued that the externalities concepts were mainly applicable in neoclassical economics such as the case where the factory may pollute the surrounding environment and affect the health of a nearby population (Hopt, 2013). In such a scenario, the externality would be in the negative scope of the third party, and the nearby population was affected negatively An example of a positive externality is in the scope of a situation where an economy has a well-educated labor force which translates to the high productivity of companies in that economy. Consumption of education is expected to generate a private benefit, but along the use of the education, there are also benefits to larger society.
Positive externalities are also referred to as external benefits or positive effects imposed by activity on the unrelated third party (Varian, 2010). Positive externalities can either rise from a production side or consumption side. A positive externality occurs when there is a positive gain both at the social level and private level. For example, research and development conducted by an organization can be positive when it increases profits of the organization and at the same time increases the general level of knowledge to the society. When a company such as Google gets to profit from using GPS tools the public experiences positive externality by accessing locations quickly.
Negative externalities or external economies which revolve around economic activities that inflict negative on the unrelated third party. It arises during production or consumption of goods or services. Pollution is a good example of negative externalities. An organization may decide to reduce cost and increase profits by implementing new operations that are more harmful to the environment. The organization will realize cost in the form of expanding its operation returns that are higher than costs. The externality also raises the aggregate cost of society and economy thus creating a negative externality. Pollution is an externality because it imposes the cost to both producer and consumer of a polluting product (Goodstein, 2011).
Consumption, production and investment decisions of households, firms, and individual effect people not directly involved in transactions (Hopt, 2013). Some externality effects are very insignificant to be easily recognized or planned for. When these effects have an impact on production and consumption of opportunities of others. When these externalities become large, limits peoples ability to budget for them because the differences between private cost or returns or cost of society as a whole become large. This is where people require government intervention or regulation to deal with the negative externalities.
Finally, to deal with externalities, a market internalizes the costs or benefits. The above costs are not always feasible, particularly when the monetary value or a good or service cannot be determined. Market efficiency declines when there is imperfection, and regulations are necessary to maximize the benefits. Transaction costs are primarily costs of negotiating solution between or among parties including the costs of negotiating the less than full information. Externalities are not the harm itself where adverse effect the activity has the other party or not. The harm can turn to an externality in the situation where transaction cost prevents the parties from negotiating by complete information.
Goodstein, E. S. (2011). Economics and the Environment. Wiley,.Varian, H.R. (2010). Intermediate microeconomics: a modern approach. New York, NY: W.W. Norton & Co
Hopt, K. J. (2013). Mediation: Principles and regulation in comparative perspective. Oxford: Oxford Univ. Press.
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