Positive vs Negative Externalities
An externality exists when a third party who is not directly involved in a transaction (as a buyer or seller of the goods or services) incurs a cost or benefit. In other words, an externality arises when a third party to a transaction experiences side effects (which can be negative or positive to them) due to transactions between buyers and sellers. When the third party benefits from this, it is called a positive externality and when the third party suffers a loss or incurs a cost it is known as a negative externality. The article offers clear explanations on each concept and outlines the similarities and differences between Positive and Negative Externalities.
What is Positive Externality?
A positive externality (also known as an external benefit) exists when the private benefit enjoyed from the production or consumption of goods and services are exceeded by the benefits as a whole to the society. In this scenario, a third party other than the buyer and seller will receive a benefit as a result of the transaction. Education and training provided to employees is a positive externality as it reduces the costs that other firms need to bear in training individuals and results in greater efficiency and productivity. The increase in productivity can result in more efficient use of raw materials, and can help improve the living standards within the economy benefiting the greater society.
Another example of a positive externality is the research into new and innovative technologies. The technological knowhow can greatly contribute to the benefit or an entire industry and can result in lower production costs, better quality, and better safety standards that benefit the producers, as well as consumers.
What is Negative Externality?
A negative externality (also called an external cost) exists when a third party suffers some sort of cost or a loss as a result of a transaction between a buyer and seller in which the third party has no involvement. One of the most well-known negative externalities is pollution. An organization may pollute the environment by burning fuels and releasing poisonous fumes to the environment which can result in problems with public health.
A more recent scenario is the economic downturn experienced as a result of the collapse of the mortgage lending market and banking system which occurred as a result of moral hazards. The best way to reduce negative externalities is to impose regulations or penalties against organizations or individuals who participate in such acts that result in higher losses to the general public.
What is the difference between Positive and Negative Externalities?
Externalities are costs or benefits that affect third parties who are not participants in the production or consumption of goods and services in a market place. 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.
Summary:
• An externality exists when a third party who is not directly involved in a transaction (as a buyer or seller of the goods or services) incurs a cost or benefit as a result of the transaction.
• A positive externality (also known as an external benefit) exists when the private benefit enjoyed from production or consumption of goods and services are exceeded by the benefits as a whole to the society.
• A negative externality (also called an external cost) exists when a third party suffers some sort of cost or a loss a result of a transaction between a buyer and seller in which the third party has no involvement.