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2009-12-311Chapter 20ExternalitiesExternalities•Anexternalityis a cost or a benefit imposedupon someone by actions taken by others.The cost or benefit is thus generated externallyto that somebody.lld bf•An externally imposed benefit is apositiveexternality.•An externally imposed cost is anegativeexternality.Examples of Negative Externalities•Air pollution.•Water pollution.•Loud parties next door.•Traffic congestion.•Second‐hand cigarette smoke.•Increased insurance premiums due toalcohol or tobacco consumption.Examples of Positive Externalities•A well‐maintained property next door thatraises the market value of your property.•A pleasant cologne or scent worn by theperson seated next to you.•Improved driving habits that reduceaccident risks.•A scientific advance.Externalities and Efficiency•Crucially, an externality impacts athird party;i.e. somebody who is not a participant in theactivity that produces the external cost orbenefitbenefit.Externalities and Efficiency•Externalities cause Pareto inefficiency;typically–too much scarce resource is allocated to anactivity which causes a negative externality–too little resource is allocated to an activitywhich causes a positive externality.
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