Question

Give an example of a positive externality and an example of a negative extemality.

Short answer

A positive externality example is education, where an individual's investment in their learning benefits the wider community through increased productivity and economic growth. A negative externality example is pollution generated by factories, negatively impacting the environment, health, and well-being of surrounding residents who did not participate in the factory's decision-making process.

Step-by-step solution

Example of a Positive Externality

A prime example of a positive externality is education. When an individual decides to invest time and money into receiving an education, they aren't the only ones benefiting from this decision. The knowledge and skills acquired by this individual can have a positive impact on society as a whole. For example, a well-educated workforce can lead to greater productivity, better decision-making, and ultimately higher economic growth. As a result, even though the initial investment was made by the individual, the benefits can extend to the wider community.

Example of a Negative Externality

An example of a negative externality is the pollution caused by factories. When a factory produces goods, it may also generate pollution in the form of harmful gases, waste, or noise. This pollution negatively affects the environment, the health of surrounding residents, and the overall well-being of the community. In this case, the factory owners are not the ones suffering the consequences of the pollution, but rather, the external parties who did not have a say in the factory's decision-making process are bearing the costs. This negative impact on unrelated parties is an example of a negative externality.

Key concepts

Positive Externality

A positive externality occurs when an individual or firm's actions result in benefits to others for which the others do not pay.

Take, for instance, someone who cultivates a beautiful garden. While the gardener enjoys their lovely flowers, neighbors and pedestrians also benefit from the improved view and neighborhood ambiance. The gardener incurs all the costs of maintaining the garden, but the aesthetic pleasure is shared by others, creating a positive externality. In economics, such external benefits encourage discussions on potential incentives, like subsidies, to promote activities yielding positive externalities for the greater good of the community.

Negative Externality

In contrast, a negative externality ensues when the actions of an individual or business lead to detrimental effects on bystanders.

A quintessential example is secondhand smoke. The smoker may derive personal satisfaction from smoking, yet the smoke causes discomfort and potential health risks to others nearby. The costs associated with this health risk and discomfort are not borne by the smoker, hence the externality is negative. Recognizing such effects, policy makers often use corrective measures like regulations and taxes to reduce the occurrence of negative externalities.

Educational Externalities

Educational externalities are a form of positive externality. When individuals pursue higher education, they typically aim to improve their own futures, but society reaps benefits too.

Educated individuals often contribute to a more informed populace, innovation, and higher productivity. These contributions lead to a more robust economy and can even strengthen democratic processes as educated citizens are more likely to participate in civic activities. Therefore, investment in education is often viewed not just as a personal good, but as a public good deserving of support through scholarships, grants, and other educational programs.

Environmental Pollution

Environmental pollution is a pervasive example of a negative externality, especially as industrial activities release pollutants into the air and water.

The burning of fossil fuels, for instance, releases greenhouse gases, leading to climate change and health issues. These costs are not factored into the price of the product or service that generated the pollution. External costs like these demonstrate why many argue for the 'polluter pays' principle, where those responsible for pollution bear the costs of managing and mitigating it, potentially through carbon taxes or emission trading systems.