Question

Give an example of a negative externality and possible externality. Explain why market outcomes are inefficient in the presence of externalities.

Answer 1

Most externalities have negative consequences. Pollution is a well-known externality which is negative. A corporation may decide to cut costs and increase profits by implementing new, more environmentally harmful operations. In the form of expanding operations , the company realizes costs but also generates returns that are higher than the costs.

Externality, however, also raises the net cost to the economy and society and makes it a negative externality. Externalities are negative if the social costs are greater than the private costs.

There are some positive externalities. Good externalities arise when those at the private and social levels provide a positive impact. A organization undertaking research and development ( R&D) may be a positive externality. R&D raises a company's private income which also has the additional benefit of rising the increased amount of awareness within a culture.

Similarly, a positive externality is the emphasis on education too. Education investment leads to a smarter and smarter work force. Organizations profit from recruiting qualified workers because they are well-informed. This benefits employers because a better educated workforce requires less investment in train services for employees

An externality causes a discrepancy or benefit between the private and social costs. Positive externality causes either higher social benefits than demand curve (positive consumption externality) or lower social costs than supply curve (technology spillovers) Negative externality causes either higher demand curve than social benefits (negative consumption externality) or higher social costs than supply curve.

The market outcome is inefficient and differs from the social optimum in the presence of externalities. In the case of a positive externality, the market output is less than the social optimum. In the case of a negative externality, the market output is greater than the social optimum