Question

What role do externalities play in the effectiveness of our economy? Explain your answer and provide an example of either a positive or negative externality(try to make it personal).

Answer 1

Externalities are the benefit or cost that a third party incurs even when it is not involved in a transaction. It could be both positive and negative. Externalities occur due to market not being efficient ie when markets fail. Market failure leads to externalities . When property rights are defined or costs and benefits to society is considered , there wont be externalities. So in order to let the market and economy be effective , it is important that market failure does not occur so that markets are effciently allocated.

Example of positive externality : education provides positive externality. When an individual is educated ,the education provides not only private benefits but social benefits as well. If i am an educated citizen, i would make sure that my surroundings are clean , that i am timely vaccined etc. All this will directly impact me but indirectly impact my neighbours , for there will be less chances of diseases in a clean environment .

Negative externality is pollution. Suppose a firm is emitting pollution in water bodies, it would affect the fishes in it and would hence affect the fishermen. This is negative externality. It has more private benefits but doesnt account for the costs to fishermen.

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