EXTERNALITIES/ EXTERNAL EFFECT
General objective
By the end of the lesson the learner should be able to explain the meaning and implications
of externality
Specific objectives
By the end of the lesson the learner should be able to:
a. explain the meaning of externality
b. describe negative externalities and give examples
c. describe positive externalities and give examples
d. graphically illustrate external costs and benefits
e. explain the types of externalities
f. explain the solutions to externality problem
g. explain the implications of externality
Introduction
This refers to the favourable and unfavourable effects which are associated with the
production or consumption of goods. Such economic effects are also referred to as spill-over
effect, neighbourhood effects or third party effects.
These externalities may either be economic gain(positive) or economic loss(Negative) to other
parties e.g. the setting up of a factory in a backward region will help to develop it. This is an
example of economic gain associated with externalities. On the other hand, environmental
pollution resulting from the establishment of a paper mill in an area may be an example of
economic loss associated with externalities. This economic gain or loss cannot be priced in the
market and apportioned to particular parties i.e. it is not possible to find out how much is the
benefit of a factory set up in a backward region or exact economic loss due to air or water
pollution of a paper mill.
Market price is fixed in terms of the internal cost of goods and services whereas social cost of
some goods and services must be borne by the society in the form of physical inconvenience
and disease.
, Examples of externalities.
Negative externalities;
A negative externality is an action of a product on consumers that imposes a negative side
effect on a third party; it is "social cost". Many negative externalities (also called "external
costs" or "external diseconomies") are related to the environmental consequences of
production and use. Air pollution from burning fossil fuels causes damages to crops,
(historic) buildings and public health. The most extensive and integrated effort to quantify and
monetise these impacts was in the European Extern E project series. Anthropogenic climate
change is attributed to greenhouse gas emissions from burning oil, gas, and coal. 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
by industries that adds poisons to the water, which harm plants, animals, and humans.
Systemic risk describes the risks to the overall economy arising from the risks which 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.
The harvesting by one fishing company in the ocean depletes the stock of available fish for
the other companies and overfishing may be the result. This is an example of a common
property resource, sometimes referred to as the Tragedy of the commons. When car owners use
roads, they impose congestion costs and higher accidents risks on all other users.
A business may purposely underfund one part of their business, such as their pension funds, in
order to push the costs onto someone else, creating an externality. Here, the "cost" is that of
providing minimum social welfare or retirement income; economists more frequently attribute
this problem to the category of moral hazards.
Consumption by one consumer causes prices to rise and therefore makes other consumers
worse off, perhaps by reducing 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 a source of market failure or inefficiency.
General objective
By the end of the lesson the learner should be able to explain the meaning and implications
of externality
Specific objectives
By the end of the lesson the learner should be able to:
a. explain the meaning of externality
b. describe negative externalities and give examples
c. describe positive externalities and give examples
d. graphically illustrate external costs and benefits
e. explain the types of externalities
f. explain the solutions to externality problem
g. explain the implications of externality
Introduction
This refers to the favourable and unfavourable effects which are associated with the
production or consumption of goods. Such economic effects are also referred to as spill-over
effect, neighbourhood effects or third party effects.
These externalities may either be economic gain(positive) or economic loss(Negative) to other
parties e.g. the setting up of a factory in a backward region will help to develop it. This is an
example of economic gain associated with externalities. On the other hand, environmental
pollution resulting from the establishment of a paper mill in an area may be an example of
economic loss associated with externalities. This economic gain or loss cannot be priced in the
market and apportioned to particular parties i.e. it is not possible to find out how much is the
benefit of a factory set up in a backward region or exact economic loss due to air or water
pollution of a paper mill.
Market price is fixed in terms of the internal cost of goods and services whereas social cost of
some goods and services must be borne by the society in the form of physical inconvenience
and disease.
, Examples of externalities.
Negative externalities;
A negative externality is an action of a product on consumers that imposes a negative side
effect on a third party; it is "social cost". Many negative externalities (also called "external
costs" or "external diseconomies") are related to the environmental consequences of
production and use. Air pollution from burning fossil fuels causes damages to crops,
(historic) buildings and public health. The most extensive and integrated effort to quantify and
monetise these impacts was in the European Extern E project series. Anthropogenic climate
change is attributed to greenhouse gas emissions from burning oil, gas, and coal. 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
by industries that adds poisons to the water, which harm plants, animals, and humans.
Systemic risk describes the risks to the overall economy arising from the risks which 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.
The harvesting by one fishing company in the ocean depletes the stock of available fish for
the other companies and overfishing may be the result. This is an example of a common
property resource, sometimes referred to as the Tragedy of the commons. When car owners use
roads, they impose congestion costs and higher accidents risks on all other users.
A business may purposely underfund one part of their business, such as their pension funds, in
order to push the costs onto someone else, creating an externality. Here, the "cost" is that of
providing minimum social welfare or retirement income; economists more frequently attribute
this problem to the category of moral hazards.
Consumption by one consumer causes prices to rise and therefore makes other consumers
worse off, perhaps by reducing 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 a source of market failure or inefficiency.
