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Exploring Economics 7th Edition

Exploring Economics (7th Edition)

Book Edition7th Edition
PublisherCengage Learning
Chapter 8, Section 8.1, In Text Question, Exercise 01
Page 213

What are externalities? Are they always bad?



Understanding externalities. (n.d.). Investopedia. Retrieved March 19, 2021, from

Finance & development. (2020, February 24). Finance & Development | F&D. Retrieved March 19, 2021, from


An externality is an expense or benefit incurred or earned by a producer that is not borne or paid for by that producer. Environmental externalities, such as natural resources or public health, are examples of externalities. A negative externality, for example, is a company that pollutes the environment, lowering property prices and harming people's health. Actions that minimize disease transmission or discourage the use of lawn treatments that runoff into rivers and thereby lead to excessive plant growth in lakes are examples of positive externalities. Externalities are not the same as parkland donations or open-source applications.


Externalities can be positive or negative, and they can result from the production or use of a product or service. The costs and benefits may be private (for a person or an organization) or social (for the entire society).


The vast majority of externalities are negative. A well-known negative externality is pollution. A business can decide to reduce costs and increase profits by introducing new environmentally harmful operations. The company incurs costs as a result of expanding operations, but it also produces returns that outweigh the costs.

However, the externality raises the economy's and society's total costs, rendering it a negative externality. If the social costs outweigh the private costs, externalities are negative.


Externalities may be beneficial in some cases. If there is a positive gain on both a private and a social level, this is referred to as a positive externality. A company's research and development (R&D) may be a beneficial externality. R&D not only raises a company's private income, but it also improves society's overall level of education. Similarly, putting a premium on education is a win-win scenario. Education investment results in a smarter and more intelligent population. Employing educated workers helps companies because they are competent. Employers profit because a more trained workforce necessitates less spending in employee training and growth.


Ways of overcoming externalities

Externalities may be addressed by taxes. Governments can place a tax on products that cause externalities, such as pollution, to help reduce the negative effects of these externalities. The levy, known as a Pigovian tax (after economist Arthur C. Pigou, and also known as a Pigouvian tax), is set at the same level as the amount of the negative externality. This tax is intended to deter actions that result in a net loss to a third party. This means that imposing this form of tax would reduce the externality's market outcome to a level that is considered competitive.


Subsidies may also be used to compensate for negative externalities by promoting the consumption of a positive one. Subsidizing orchards that plant fruit trees to provide beneficial externalities to beekeepers is one example.


Governments may also enact laws to mitigate the negative impact of externalities. The most commonly used approach is legislation. To alleviate the detrimental impact of externalities, the public frequently looks to policymakers to pass and enforce legislation and regulation. Environmental laws and health-related legislation are two examples.



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