Question

2. Define externality and distinguish between positive and negative externality and their impact on production, using examples where possible.

3. How can a government correct for positive and negative externalities?

Answer 1

In economics, an externality is the cost or benefit that affects a third party who did not choose to incur that cost or benefit.

A positive externality has a positive effect on the bystander, while a negative externality has a negative effect on the bystander.

A negative externality :A corporation may decide to cut costs and increase profits by implementing new operations that are more harmful to the environment.

A positive externality: Appreciation in property values that result from construction of new roads, mass transit systems, etc. and travel time savings due to higher accessibility.

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Government can play a role in reducing negative externalities by taxing goods when their production generates spillover costs. This taxation effectively increases the cost of producing such goods. Such taxation attempts to make the producer pay for the full cost of production.

Government can play a role in encouraging positive externalities by providing subsidies for goods or services that generate spillover benefits. Such subsidies provide an incentive for firms to increase the production of goods that provide positive externalities.