Externalities
Synonyms
Definition
Externalities are the “[b]enefits or costs of an individual’s activity that the individual does not receive or bear” (Ekelund et al. 2006, p. 415). They arise whenever the actions of one person affect the welfare of another. There are positive (when others receive a benefit) and negative (when others are burdened with costs) externalities that may arise from production and consumption decisions. When the production or consumption of a good carries externalities, the effects spill over outside of the market and consequently are not fully reflected in the good’s price. Widespread consumption of schooling leads to a reduction in the crime rate, a positive externality (Lochner and Moretti 2004). Steel production generates air pollution, a negative externality. You receive a benefit living among educated citizens and you pay a cost living downwind of a steel plant, but neither is likely to influence the market price of...
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