Question

Question 1

A. Define an externality.

B. Distinguish a negative externality from a positive externality, and give one example of each.

C. What is meant by a production externality as opposed to a consumption externality?

D. Give one example of a negative production externality and one of a positive consumption externality.

Answer 1

Externality means the actions of a group of people having a positive or a negative impact on a third party. Generally, the social benefit should be greater than the private benefit so that society protects its members and is productive.

A positive externality as its name suggests is a benefit that third parties enjoy as a result of a transaction, production, or consumption between the buyer and the seller.

A negative externality, on the other hand, is the cost that a third party has to bear as a result of a transaction in which the third party has no involvement. Negative and positive externalities both occur as a result of economic activity and an economy must always strive to reduce its negative externalities through regulations and penalties while increasing its positive externalities by giving incentives to train individuals, research on new technology, etc.

A positive externality is also termed as “external benefit” whereas; the negative externality is also called “external cost”.