Question

Describe negative within-firm externalities as they pertain to cash flow versus accounting income.

Answer 1

Negative externalities can lead to over-production. The producer does not pay the external cost. Positive externalities lead to underproduction; the benefit is generated without profit. Prices do not reflect the full costs or benefits. Consumers neither bear all costs nor reap all benefits. Those who suffer from negative externalities do so involuntarily. A voluntary exchange reduces total economic activity.

Negative Externalities

A project can impact other cash flows. It occurs when a new product diminishes the sale of existing products.

Cash Flow

• Opportunity cost represents cash flow that the firm gives up
• externalities are cash flows to other projects that result from the firm taking this project

If revenues are not as much as expected, net cash flow loss is a cost to the project. The annual loss will not be that much. It would save on cash operating costs if sales dropped. In this case, the externality is negative.

Negative externality - the cost imposed on the environment, and, third parties; for example, land contamination. GDP excludes the externalities on consumption or production. Limited increases in input utilization reduce negative utilization. Externalities provide justification for Pigouvian taxes, and, regulation.

An example of a negative within-firm externality is cannibalization; a new project, or, the product reduces cash flows