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Positive and Negative Externalities July 14, 2010

Posted by petrarcanomics in Role of Government.
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Positive externalities or external benefits or spillover benefits are goods and services that have beneficial effects for third parties who are not directly involved in the transaction for those goods. Classic examples of positive externalities are:

  • education
  • vaccine shots
  • home renovations
  • use of alternative energy

Markets tend to underproduce positive externalities because the benefits to third parties not involved in the transaction are  not typically realized and understood by those third parties who benefit from them. Government solution to this under production is to subsidize aether consumers, producers, or some amount of both to cause society to produce the most efficient and optimum level of production.

Negative externalities are goods and services that dump costs onto third parties that are not directly involved in the transaction. Classic examples of negative externalities are:

  • pollution
  • smoking
  • drinking and driving
  • failure to maintain a  home

Markets generally over produce negative externalities because direct costs to the producer are artificially low because the producer is getting away with dumping costs onto third parties not involved in the transaction. Government solves the market failure of negative externalities by internalizing the costs of production to producers through taxes, fines, and civil court settlements which drive the societal costs of production back onto the producers.

See Reffonomics for more on these topics: Negative Externality, Positive Externality, Externalities.

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