Economic activities can impose unaccounted-for costs on society, known as negative externalities. These inefficiencies often lead to government interventions and have widespread implications, affecting issues as significant as climate change and public health.
Definition
- Externalities: Economic side effects or by-products that affect an uninvolved third party; can be either positive or negative.
- Negative Externalities: Costs that are suffered by a third party as a consequence of an economic transaction they were not a party to.
Types of Negative Externalities
- Production Externalities: Occur in the production phase of a good or service. Example: Pollution from a factory affecting nearby residents.
- Consumption Externalities: Occur during the consumption of a good or service. Example: Secondhand smoke.
Characteristics
- Non-Excludability: Affected parties cannot easily opt out of suffering the externality.
- Non-Rivalry: The cost imposed on one does not diminish the cost imposed on another.
Key Concepts
- Marginal Social Cost (MSC): The total cost society pays for the production of an extra unit of a good or service.
- Marginal Private Cost (MPC): The cost that the producer incurs in the production of an extra unit of a good or service.
- Social Welfare: The overall well-being of a society, often diminished by negative externalities.
Classic Examples
- Air Pollution: Industries emitting pollutants, affecting public health.
- Overfishing: Depleting fish stocks affects future fishing opportunities for all.
- Traffic Congestion: Individual car use leads to increased travel time for all.
Measurement
- Pigouvian Taxes: Taxes designed to correct the negative externality by aligning private cost with social cost.
- Coase Theorem: Suggests that under perfect property rights and zero transaction costs, externalities can be efficiently internalized.
Market Failure
Incomplete Markets: Markets that do not account for externalities fail to allocate resources efficiently.
Policy Solutions
- Regulation: Government intervention to limit or ban activities causing externalities.
- Cap-and-Trade: Allowing firms to buy and sell rights to emit a set amount of a pollutant.
Global Perspective
- Climate Change: A quintessential example of global negative externalities, impacting nations unequally.
- Global Commons: Resources like oceans and atmosphere, shared globally, often suffer from the “Tragedy of the Commons.”
Economic Theories Involved
Welfare Economics: Studies how the allocation of resources affects social welfare.
Consequences
Income Inequality: Those with fewer resources often disproportionately suffer from negative externalities.
Moral and Ethical Considerations
Intergenerational Equity: Future generations cannot participate in decisions affecting them, such as environmental degradation.
