Question

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

Answer 1

Answer : Meaning of Externality :

Externality means cost or benefit that has been generated from an economic activity of the producer which has been affected by the whole economy and its people. It is affected the third party which is neither producer nor consumer.

Externality is of two types :

• Positive externality : Positive externality is an external benefits that has been imposed on third party It has positive effect. Example : Research into new technologies is an example of positive externality. In this situation except from producer and consumer third party also benefited from it.
• Negative externality : Negative externality is an external cost that has been beared by the third party . It has been generated from activity of the producer and it is beared by third party. Example : Air pollution from factory is an example of negative externality. It can imposed health and cleaning problem that has been beared by whole society.

The reasons for which externality occurs because

• When an economic activity of the producer affected a party who neither pays not get paid.
• When a market fails to allocate resources efficiently.
• It occurs when the cost or benefit of the market transaction falls on the third party which is neither producer nor consumer.