Question

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

Short answer

A positive externality example is a homeowner planting a beautiful garden that provides enjoyment to neighbors and passersby who are not directly involved in the decision. A negative externality example is a factory emitting air pollution, causing health problems for nearby residents who are not connected to the factory's production process.

Step-by-step solution

Define Externalities

Externalities are the effects of a decision or action on third parties that are not directly involved in the decision or action. These effects can be either positive or negative.

Positive Externality Example

A positive externality occurs when an action taken by an individual or firm delivers benefits to other people who are not directly involved in the action. For example, consider a homeowner planting a beautiful garden in their front yard. Neighbors and passersby enjoy the sight of the garden, increasing their satisfaction and overall well-being. This positive effect on others, who are not directly involved in the decision to plant the garden, is a positive externality.

Negative Externality Example

A negative externality occurs when an action taken by an individual or firm imposes costs on other people who are not directly involved in the action. For example, consider a factory that emits large amounts of air pollution leading to health problems for people living in nearby areas. The factory's decision to produce goods, which results in air pollution, causes harm and health costs to the nearby residents who are not connected to the factory's production process. This negative effect on others is a negative externality.