what is an externality 
an externality is a cost or benefit that is caused by one party but financially incurred or received by another externalities can be negative or positive a negative externality is the indirect imposition of a cost by one party onto another a positive externality on the other hand is when one party receives an indirect benefit as a result of actions taken by another externalities can stem from either the production or consumption of a good or service the costs and benefits can be both private to an individual or an organization or social meaning it can affect society as a whole investopedia madelyn goodnightunderstanding externalitiesexternalities occur in an economy when the production or consumption of a specific good or service impacts a third party that is not directly related to the production or consumption of that good or service almost all externalities are considered to be technical externalities technical externalities have an impact on the consumption and production opportunities of unrelated third parties but the price of consumption does not include the externalities this exclusion creates a gap between the gain or loss of private individuals and the aggregate gain or loss of society as a whole the action of an individual or organization often results in positive private gains but detracts from the overall economy many economists consider technical externalities to be market deficiencies and this is the reason people advocate for government intervention to curb negative externalities through taxation and regulation externalities were once the responsibility of local governments and those affected by them so for instance municipalities were responsible for paying for the effects of pollution from a factory in the area while the residents were responsible for their healthcare costs as a result of the pollution after the late 1990s governments enacted legislation imposing the cost of externalities on the producer many corporations pass the cost of externalities on to the consumer by making their goods and services more expensive types of externalitiesexternalities can be broken into two different categories first externalities can be measured as good or bad as the side effects may enhance or be detrimental to an external party these are referred to as positive or negative externalities second externalities can be defined by how they are created most often these are defined as a production or consumption externality most externalities are negative pollution is a well known negative externality a corporation may decide to cut costs and increase profits by implementing new operations that are more harmful to the environment the corporation realizes costs in the form of expanding operations but also generates returns that are higher than the costs however the externality also increases the aggregate cost to the economy and society making it a negative externality externalities are negative when the social costs outweigh the private costs some externalities are positive positive externalities occur when there is a positive gain on both the private level and social level research and development r d conducted by a company can be a positive externality r d increases the private profits of a company but also has the added benefit of increasing the general level of knowledge within a society similarly the emphasis on education is also a positive externality investment in education leads to a smarter and more intelligent workforce companies benefit from hiring employees who are educated because they are knowledgeable this benefits employers because a better educated workforce requires less investment in employee training and development costs a production externality is an instance where an industrial operation has a side effect this is often the type of externality used as example as it is easy to envision an environmental catastrophe caused by improperly stored chemicals by a chemical company because of how the company produced its goods or protected its waste an externality occurred externalities may also occur based on when or how a consumer base utilizes resources consider the example of how you get to work those who choose to drive are creating a pollution externality by driving their own car those who choose to take public transit or walk are not causing the same externality instead of a side effect occurring because something is being produced an externality is caused because of an item being consumed these four types of externalities above are often combined to define a single externality for example an externality may be a positive production negative production positive consumption or negative consumption externality externality solutionsthere are solutions that exist to overcome the negative effects of externalities these can include those from both the public and private sectors taxes are one solution to overcoming externalities to help reduce the negative effects of certain externalities such as pollution governments can impose a tax on the goods causing the externalities the tax called a pigovian tax named after economist arthur c pigou is considered to be equal to the value of the negative externality this tax is meant to discourage activities that impose a net cost to an unrelated third party that means that the imposition of this type of tax will reduce the market outcome of the externality to an amount that is considered efficient subsidies can also overcome negative externalities by encouraging the consumption of a positive externality one example would be to subsidize orchards that plant fruit trees to provide positive externalities to beekeepers this nudge has the potential to influence behavioral economics as additional incentives one way or another way dictate the choices that are made the subsidy is often placed on an opposing item to detract from a specific activity as well for example government incentives to upgrade to more energy efficient renovations subtly discourages consumers against options with more externalities governments can also implement regulations to offset the effects of externalities regulation is considered the most common solution the public often turns to governments to pass and enact legislation and regulation to curb the negative effects of externalities several examples include environmental regulations or health related legislation the primary issue with government regulation of externalities is the need for consistent and reliable information to track the externality is being managed or overcome consider regulation against pollution the government put forth resources to ensure that the legislation put in place is actually being followed including holding bad actors accountable for not properly addressing their externality real world examples of externalitiesmany countries around the world enact carbon credits that may be purchased to offset emissions these carbon credit prices are market based that may often fluctuate in cost depending on the demand of these credits to other market participants one program within the united states is the regional greenhouse gas initiative rggi the rggi is made up of 12 states california and 11 northeast states rggi is a mandatory cap and trade program that limits carbon dioxide emissions from the power sector 1different agencies are imposed a cap on externalities though they can trade resources to change what their cap is agencies that struggle managing their externality i e pollution may need to purchase additional credits to have their cap increased other agencies that conquer their externality may sell part of their cap space to recover capital likely used to overcome their externalities 