Many externalities arise between producers, between consumers or between consumers and producers. Externalities can be negative when the action of one party imposes costs on another, or positive when the action of one party benefits another.
Negative is an example of an externality because the consumption of street lighting has an effect on bystanders that is not compensated for by the consumers of the lighting. A
negative externality (also called "
external cost" or "external diseconomy") is an economic activity that imposes a negative effect on an unrelated third party, not captured by the market price. It can arise either during the production or the consumption of a good or service. Pollution is termed an externality because it imposes costs on people who are "external" to the producer and consumer of the polluting product.
Barry Commoner commented on the costs of externalities: Clearly, we have compiled a record of serious failures in recent technological encounters with the environment. In each case, the new technology was brought into use before the ultimate hazards were known. We have been quick to reap the benefits and slow to comprehend the costs. Many negative externalities are related to the environmental consequences of production and use. The article on
environmental economics also addresses externalities and how they may be addressed in the context of environmental issues.
Negative production externalities and their negative impacts Examples for
negative production externalities include: •
Air pollution from burning
fossil fuels. This activity causes damages to crops, materials and (historic) buildings and public health. •
Anthropogenic climate change as a consequence of
greenhouse gas emissions from the burning of fossil fuels and the rearing of livestock. The
Stern Review on the Economics of Climate Change says "Climate change presents a unique challenge for economics: it is the greatest example of
market failure we have ever seen." •
Water pollution from industrial effluents can harm plants, animals, and humans •
Spam emails during the sending of unsolicited messages by email. •
Government regulation: Any costs required to comply with a law, regulation, or policy, either in terms of time or money, that are not covered by the entity issuing the edict (see also
unfunded mandate). •
Noise pollution during the production process, which may be mentally and psychologically disruptive. •
Systemic risk: the risks to the overall economy arising from the risks that the banking system takes. A condition of
moral hazard can occur in the absence of well-designed
banking regulation, or in the presence of badly designed regulation. • Negative effects of
Industrial farm animal production, including "the increase in the pool of antibiotic-resistant bacteria because of the
overuse of antibiotics; air quality problems; the contamination of rivers, streams, and coastal waters with concentrated animal waste; animal welfare problems, mainly as a result of the extremely close quarters in which the animals are housed." • The depletion of the stock of fish in the ocean due to
overfishing. This is an example of a
common property resource, which is vulnerable to the
tragedy of the commons in the absence of appropriate environmental governance. • In the United States, the cost of storing
nuclear waste from
nuclear plants for more than 1,000 years (over 100,000 for some types of nuclear waste) is, in principle, included in the cost of the electricity the plant produces in the form of a fee paid to the government and held in the
nuclear waste superfund, although much of that fund was spent on
Yucca Mountain nuclear waste repository without producing a solution. Conversely, the costs of managing the long-term risks of disposal of chemicals, which may remain hazardous on similar time scales, is not commonly internalized in prices. The USEPA regulates chemicals for periods ranging from 100 years to a maximum of 10,000 years.
Negative consumption externalities Examples of
negative consumption externalities include: •
Noise pollution: Sleep deprivation due to a neighbor listening to loud music late at night. •
Antibiotic resistance, caused by increased usage of antibiotics: Individuals do not consider this efficacy cost when making usage decisions. Government policies proposed to preserve future antibiotic effectiveness include educational campaigns, regulation,
Pigouvian taxes, and patents. •
Passive smoking: Shared costs of declining health and vitality caused by smoking or alcohol abuse. Here, the "cost" is that of providing minimum social welfare. Economists more frequently attribute this problem to the category of
moral hazards, the prospect that parties insulated from risk may behave differently from the way they would if they were fully exposed to the risk. For example, individuals with insurance against automobile theft may be less vigilant about locking their cars, because the negative consequences of automobile theft are (partially) borne by the insurance company. •
Traffic congestion: When more people use public roads, road users experience congestion costs such as more waiting in traffic and longer trip times. Increased road users also increase the likelihood of road accidents. • Price increases: Consumption by one party causes prices to rise and therefore makes other consumers worse off, perhaps by preventing, reducing or delaying their consumption. These effects are sometimes called "
pecuniary externalities" and are distinguished from "real externalities" or "technological externalities". Pecuniary externalities appear to be externalities, but occur within the market mechanism and are not considered to be a source of
market failure or inefficiency, although they may still result in substantial harm to others. • Weak
public infrastructure, air pollution, climate change, work misallocation, resource requirements and land/space requirements as in the
externalities of automobiles.
Negative externalities outside production and consumption Some negative externalities involve neither production nor consumption. One such externality is the spread of
infectious diseases to others resulting from one’s exercising the right to decline
preventive or
therapeutic medical care. A specific example is when
vaccine hesitancy prevents or undoes the attainment of
population immunity and thus leads to
outbreaks.
Positive A positive externality (also called "
external benefit" or "external economy" or "beneficial externality") is the positive effect an activity imposes on an unrelated third party. Similar to a negative externality, it can arise either on the production side, or on the consumption side.
Positive production externalities Examples of
positive production externalities • A
beekeeper who keeps the
bees for their
honey. A side effect or externality associated with such activity is the
pollination of surrounding crops by the bees. The value generated by the pollination may be more important than the value of the harvested honey. • The corporate development of some
free software (studied notably by
Jean Tirole and
Steven Weber) •
Research and development, since much of the economic benefits of research are not captured by the originating firm. • An industrial company providing first aid classes for employees to increase on the
job safety. This may also save lives outside the factory. • Restored historic buildings may encourage more people to visit the area and patronize nearby businesses. • A foreign firm that demonstrates up-to-date technologies to local firms and improves their productivity. •
Public transport can increase economic welfare by providing transit services to other economic activities, however the benefits of those other economic activities are not felt by the operator, it can also decrease the negative externalities of increasing road patronage in the absence of a
congestion charge. • The personal cost of an education will have an external benefit to society.
Positive consumption externalities Examples of
positive consumption externalities include: • An individual who maintains an attractive house may confer benefits to neighbors in the form of increased
market values for their properties. This is an example of a pecuniary externality, because the positive spillover is accounted for in market prices. In this case, house prices in the neighborhood will increase to match the increased real estate value from maintaining their aesthetic. (such as by mowing the lawn, keeping the trash orderly, and getting the house painted) • Anything that reduces the rate of transmission of an infectious disease carries positive externalities. This includes vaccines, quarantine, tests and other diagnostic procedures. For airborne
infections, it also includes masking. For waterborne diseases, it includes improved sewers and sanitation. (See
herd immunity) • Increased
education of individuals, as this can lead to broader society benefits in the form of greater economic
productivity, a lower
unemployment rate, greater household mobility and higher rates of
political participation. • An individual buying a product that is interconnected in a network (e.g., a
smartphone). This will increase the usefulness of such phones to other people who have a video cellphone. When each new user of a product increases the value of the same product owned by others, the phenomenon is called a network externality or a
network effect. Network externalities often have "
tipping points" where, suddenly, the product reaches general acceptance and near-universal usage. • In an area that does not have a
public fire department, homeowners who purchase
private fire protection services provide a positive externality to neighboring properties, which are less at risk of the protected neighbor's fire spreading to their (unprotected) house. Collective solutions or
public policies are implemented to
regulate activities with positive or negative externalities.
Positional The sociological basis of positional externalities is rooted in the theories of
conspicuous consumption and
positional goods. , a major horse racing competition, some audience members wear expensive hats to display their wealth and status. Conspicuous consumption (originally articulated by
Veblen, 1899) refers to the consumption of goods or services primarily for the purpose of displaying social status or wealth. In simpler terms, individuals engage in conspicuous consumption to signal their economic standing or to gain social recognition. Positional goods (introduced by
Hirsch, 1977) are such goods, whose value is heavily contingent upon how they compare to similar goods owned by others. Their desirability is or derived utility is intrinsically tied to their relative scarcity or exclusivity within a particular social context. The economic concept of Positional externalities originates from
Duesenberry's
Relative Income Hypothesis. This hypothesis challenges the conventional microeconomic model, as outlined by the Common Pool Resource (CPR) mechanism, which typically assumes that an individual's utility derived from consuming a particular good or service remains unaffected by other's consumption choices. Instead, Duesenberry posits that individuals gauge the utility of their consumption based on a comparison with other consumption bundles, thus introducing the notion of relative income into economic analysis. Consequently, the consumption of positional goods becomes highly sought after, as it directly impacts one's perceived status relative to others in their social circle. Example: consider a scenario where individuals within a social group vie for the latest luxury cars. As one member acquires a top-of-the-line vehicle, others may feel compelled to upgrade their own cars to preserve their status within the group. This cycle of competitive consumption can result in inefficient allocation of resources and exacerbate income inequality within society. The consumption of positional goods engenders negative externalities, wherein the acquisition of such goods by one individual diminishes the utility or value of similar goods held by others within the same reference group. This positional externality, can lead to a cascade of overconsumption, as individuals strive to maintain or improve their relative position through excessive spending. Positional externalities are related, but not similar to Percuniary externalities.
Pecuniary Pecuniary externalities are those which affect a third party's profit but not their ability to produce or consume. These externalities "occur when new purchases alter the relevant context within which an existing positional good is evaluated."
Robert H. Frank gives the following example: :if some job candidates begin wearing expensive custom-tailored suits, a side effect of their action is that other candidates become less likely to make favorable impressions on interviewers. From any individual job seeker's point of view, the best response might be to match the higher expenditures of others, lest her chances of landing the job fall. But this outcome may be inefficient since when all spend more, each candidate's probability of success remains unchanged. All may agree that some form of collective restraint on expenditure would be useful." Inframarginal externalities differ from other externalities in that there is no benefit or loss to the marginal consumer. At the relevant margin to the market, the externality does not affect the consumer and does not cause a market inefficiency. The externality only affects at the inframarginal range outside where the market clears. These types of externalities do not cause inefficient allocation of resources and do not require policy action.
Technological Technological externalities directly affect a firm's production and therefore, indirectly influence an individual's consumption; and the overall impact of society; for example
Open-source software or
free software development by corporations. These externalities occur when technology spillovers from the acts of one economic agent impact the production or consumption potential of another agency. Depending on their nature, these spillovers may produce positive or negative externalities. The creation of new technologies that help people in ways that go beyond the original inventor is one instance of positive technical externalities. Let us examine the instance of research and development (R&D) inside the pharmaceutical sector. In addition to possible financial gain, a pharmaceutical company's R&D investment in the creation of a new medicine helps society in other ways. Better health outcomes, higher productivity, and lower healthcare expenses for both people and society at large might result from the new medication. Furthermore, the information created via research and development frequently spreads to other businesses and sectors, promoting additional innovation and economic expansion. For example, biotechnology advances could have uses in agriculture, environmental cleanup, or renewable energy, not just in the pharmaceutical industry. However, technical externalities can also take the form of detrimental spillovers that cost society money. Pollution from industrial manufacturing processes is a prime example. Businesses might not be entirely responsible for the expenses of environmental deterioration if they release toxins into the air or rivers as a result of their production processes. Rather, these expenses are shifted to society in the form of decreased quality of life for impacted populations, harm to the environment, and health risks. In addition, workers in some industries may experience job displacement and unemployment as a result of disruptive developments in labor markets brought about by technological improvements. For instance, individuals with outdated skills may lose their jobs as a result of the automation of manufacturing processes through robots and artificial intelligence, causing social and economic unrest in the affected areas. ==Supply and demand diagram==