Question

Discuss the concept of externalities. What do externalities have to do with the environment?

Answer 1

Externalities refer to the costs or benefits arising out of an economic transaction which affects parties outside the transaction; however, which has not been taken into consideration in the market price of the transaction. Externalities can be negative or positive. Positive externalities create benefits and negative externalities impose costs on parties outside the transactions. For example, an airport might cause noise pollution which might negatively affect the residents living nearby; however, the cost of this noise may not be taken into account in airfares to compensate these residents. So, this noise is a negative externality.

The environment is often subject to negative externalities. Various economic activities result in negative consequences for the environment as a whole. However, market prices do not reflect the costs imposed on the environment. For example, commercial activities affect the marine environment, disturb the pH balance of sea, pollutes water through oil leaks, chemical leaks, etc. Such environmental degradation has long-term consequences. However, market prices do not reflect these costs.