Question

Briefly explain what is meant by the term "externality" and how it occurs.

Answer 1

Answer:

Externality is the unintentional cost or benefit that occurs during the process of production or consumption. That is, the cost or benefit that affects a third party tthat did not choose to incur that cost or enjoy that benefit. Externality lies outside the intended result of the action of production or consumption.

Externality occurs as a by-product of the action of consumption or production. Cost that occurs in this way is called negative externality as it adversely affects others. Benefit is called positive exrternality as it benefits the others involved.

Negative externality that is the result of a production process is called negative production externality, for example, air pollution that occurs as a result of production activity of a chemical factory. Negative externality that results from consumption is called negative consumption externality, for example, loud noise of music that disturbs the neighbors.

Similary there are positive production externality and positive consumption externality. Positive production externallity is the benefit to others from a production process, for example, a bee farmer helps the flowers in his neighbor's garden to pollinate. Positive consumption externality is the benefit others get when something is consumed, for example, vaccination against measles helps stop the spread of the disease.

Thus, externality occurs unintentionally and causes cost or benefit to others.