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HomeHomework HelpeconomicsExternalities in Economics

Externalities in Economics

Externalities are economic side effects that affect third parties who are not directly involved in a transaction. They can be positive, such as the benefits of education on society, or negative, like the costs of pollution. Understanding externalities is crucial in economics because they highlight the importance of government intervention, such as taxes and subsidies, to promote socially efficient outcomes.

intermediate
2 hours
Economics
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Overview

Externalities play a crucial role in economics by influencing the decisions of individuals and businesses. They can lead to market failures when the costs or benefits are not reflected in market prices, resulting in inefficient resource allocation. Understanding both positive and negative externalit...

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Key Terms

Externality
A cost or benefit incurred by a third party not involved in a transaction.

Example: Pollution from a factory affects nearby residents.

Positive Externality
A benefit received by a third party due to an economic transaction.

Example: A well-educated population benefits society.

Negative Externality
A cost imposed on a third party due to an economic transaction.

Example: Traffic congestion caused by increased car usage.

Social Cost
The total cost to society, including both private costs and external costs.

Example: The social cost of pollution includes health care costs.

Market Failure
A situation where the allocation of goods and services is not efficient.

Example: When externalities lead to overproduction or underproduction.

Public Goods
Goods that are non-excludable and non-rivalrous, benefiting everyone.

Example: National defense is a public good.

Related Topics

Public Goods
Study of goods that are non-excludable and non-rivalrous, impacting externalities.
intermediate
Market Structures
Understanding different market structures helps analyze how externalities function within them.
intermediate
Cost-Benefit Analysis
A method to evaluate the economic worth of projects, considering externalities.
advanced

Key Concepts

positive externalitiesnegative externalitiessocial costmarket failure