Externalities

 Definition:

An externality is an uncompensated impact of one person’s action on the

well-being of a bystander. It can stem from either the production or the consumption of a
good or service. The costs and benefits can be both private—to an individual or an
organization—or social, and it can affect society as a whole.

 Types:

There are two types of externalities

1. Positive externality
2. Negative externality
1. Positive externality:

A positive externality occurs when the spillover effects of an economic

activity confer benefits on third parties who are not directly involved in the transaction. In
other words, it is an unintended positive consequence that occurs beyond the primary
participants.

Example

Examples of positive externalities include education, vaccination,

research and development etc. as it acts positively on a bystander ultimately.

2. Negative externality:

A negative externality occurs when the costs or negative consequences

of an economic activity are borne by third parties who are not involved in the transaction.
These externalities arise when the producer or consumer does not fully bear the costs
associated with their actions.

Example

Examples of negative externalities include air pollution, deforestation,

space junk etc. as it acts negatively on a bystander.
Example of Externalities

There are some examples of externalities that we see daily in our life but do not recognize it

1. Emission of Greenhouse Gas:

In our daily life, there are many products are formed in the factories and
transport them to the market. Greenhouse gas (GHG) emissions, in particular, are produced,
CO2, SO2, NO, NO2 and many more, during the production, transport and disposal/recycling of
all kinds of goods and greenhouse gas emissions have most likely a huge negative impact and
exert negative externality on society’s welfare by fostering climate change that tremendously
exceeds the individual gains of the market actors.  Neither the producers nor the consumers of
goods that are causing GHG emissions are directly and personally affected by these emissions
but the people living those areas are directly affected and suffer from various diseases and
allergies like Pneumonia, Asthma etc.

To reduce the externality of Greenhouse gas emission, Government needs

to do the following things:

 Impose higher taxes on those factories and production houses that release greenhouse
gas into the environment.
 Demote those products that produce greenhouse gas during their production like
livestock products.
 Try to use renewable energy resources for the production and transportation of goods
that reduces that production of CO2, methane etc.
2. Education: Good Citizen Effect:

If you get education, you will get good salary and you will become
successful. This is the thinking of everyone that he gets education for himself but getting
education acts as a positive externality on the society. Education makes you not only a
successful person in the future but also a good and manner citizen of a society. A person
learns discipline, respect of elders and youngers, communication skills and knowledge during
his school, college and university and, ultimately, it reflects everyone in a society. Thus,
education acts as a positive externality for the society.
 To promote the getting of good quality education, government should take
the following steps:

 Hire qualified teachers and give them good salary packages.

 Do advertisement and tell the public about the importance of getting education.
 Order private educational institutes to lower their monthly or annual fees and give
good quality education; otherwise, get a huge penalty.
3. Environmental effects of using plastic shopping bags and water
bottles:

Nowadays, people use plastic water bottles and plastic shopping bags and
it directly pollutes our environment because they are non-biodegradable. Plastic products act
as a negative externality to our environment and the organism living in that environment.
People use plastic products and throw them outside whether it is buried into land causing soil
erosion and land infertility or some wild animals eat it causing extinction of wild animals. It
also exerts negative externality on human beings as it causes many diseases like cancer.

To demote the usage of plastic shopping bags and water bottles,

government should implement the following policies:

 Use paper bags or cloth bags instead of plastic bags and use glass or biodegradable
plastic to make water bottles
 Promote the 3R- method (Reduce, reuse and recycle) and reduce the production of
plastic.
 Increase tax on plastic and plastic products to reduce their sales.
4. Bees

Bees make honey in their honeycomb. First, they go to the flowers,

sucking the flower sap and convert it into honey. They are also helpful in cross pollination of
food-based crops. Hence, bees exert positive externality on us and the environment as they
provide honey and helps to increase the high crops production by cross pollination. Bees can
act as bioindicators of environmental health. Changes in bee populations or behaviors may
signal shifts in ecosystems, including pollution levels, habitat loss, or climate change impacts.
The externalities of bees in this context are their potential role in alerting us to environmental
problems and prompting necessary actions for mitigation. Some species of bees, such as
solitary cavity-nesting bees, help control agricultural pests by preying on them or by
parasitizing pests' eggs or larvae. This natural pest control service provided by bees can
reduce the need for synthetic pesticides and benefit neighboring crops, leading to positive
externalities for agricultural systems.

Space Junk:

Space junk or Space debris is the sending of defunct human made objects
in space. It includes derelict spacecraft, mission related debris, and particularly numerous in Earth
orbit, fragmentation debris from the breakup of derelict rocket bodies and spacecraft. Space debris is
typically a negative externality—it creates an external cost on others from the initial action to
launch or use a spacecraft in near-Earth orbit—a cost that is typically not taken into account
nor fully accounted for in the cost by the launcher or payload owner. Several spacecraft, both
crewed and uncrewed, have been damaged or destroyed by space debris. The measurement,
mitigation, and potential removal of debris are conducted by some participants in the space
industries.

To reduce the negative externality of space junk, government should need

to adopt the following reasons:

 Make sure that satellites are removed from orbit in a reasonable amount of time once
they are no longer active
 Make a department that records the expiry date of every satellite and they call back
those satellites timely before they expire.
 Use materials and components on space crafts that are less likely to generate debris
during collisions or explosions.
5. Junk Food:

Junk food is used to describe food and drinks low in nutrients and high in
kilojoules, saturated fat, added sugar and/or added salt. It exerts both positive and negative
externalities but are generally associated with negative consequences. One of the significant
negative externalities of junk food is the burden it places on public health systems. The rise in
obesity and related health issues leads to increased healthcare expenditure. Governments and
individuals have to bear the financial burden of treating diet-related diseases, including
medical expenses, hospital stays, medications, and long-term care. Unhealthy eating habits
associated with junk food can lead to decreased productivity in individuals. The production
and distribution of junk food have detrimental effects on the environment. Large-scale
farming practices that supply ingredients for junk food often involve the use of pesticides,
fertilizers, and intensive water consumption. The production process also contributes to
greenhouse gas emissions and deforestation, further exacerbating climate change and
environmental degradation.

To reduce the negative externality of junk food, we should need to follow

following things:

 Promote public awareness campaigns and educational programs to increase

knowledge about the health risks associated with excessive consumption of junk food.
 Introduce or increase taxes on junk food products to discourage their consumption and
offset the negative externalities they create.
 Provide subsidies and incentives for the production, distribution, and consumption of
healthier food options such as fruits, vegetables, and whole grains that demote the
usage of fast food.
6. Air Quality in India and China:

Today, India and China are one of the biggest economic countries in
the world. China is considered as a next superpower and India become so much successful till
2050 but both countries rank highest according to air pollution index, exerting negative
externality on the people living in India and China. Due to air pollution, these people suffer
from very hazardous respiratory diseases and allergies like pneumonia, emphysema, asthma,
bronchitis, lung cancer and many more that lead them to the throne of death. This is caused
due to high industrialization and development in cities. Poor air quality negatively affects the
quality of life for individuals living in affected areas. It leads to restricted outdoor activities,
limited access to clean air, and decreased overall well-being. Air pollution has detrimental
effects on productivity and economic output. The health impacts of poor air quality, such as
increased absenteeism, reduced work capacity, and decreased cognitive function, can hinder
workforce productivity and economic growth.

There are some strategies that these countries made to reduce the air
pollution out of which some are already implemented. These are as follow
  Implement and enforce stringent air pollution control regulations, including emission
standards for industries, vehicles, and power plants. Strengthen monitoring and
enforcement mechanisms to ensure compliance.
 Promote the transition to cleaner and renewable energy sources, such as solar and
wind power, and reduce reliance on fossil fuels. Encourage the adoption of energy-
efficient technologies and practices.
 Improve public transportation infrastructure, promote the use of electric vehicles, and
implement policies that discourage the use of high-polluting vehicles. Develop and
enforce stricter vehicle emission standards.
7. Overfishing:

In our world, there are fishermen that catch fishes and sell them to the
market to earn their livelihood. Overfishing is the scenario in which excessive number of
fishes are caught from waterbodies like lake, canals, rivers etc. It exerts negative externality
and a huge impact in the extinction of fishes and other marine life. Overfishing depletes fish
populations beyond their sustainable levels. This leads to a decline in fish stocks, disrupting
the delicate balance of marine ecosystems. It can result in the collapse of fish populations,
loss of biodiversity, and the disruption of food chains. Overfishing can disrupt the natural
balance within marine ecosystems. Removing certain species at an unsustainable rate can
cause imbalances in predator-prey relationships, alter habitats, and impact the overall health
and resilience of marine ecosystems. Overfishing can undermine food security and nutrition,
especially for communities that rely heavily on fish as a primary source of protein. Depleted
fish stocks can lead to reduced availability and increased prices of fish, making it harder for
vulnerable populations to access nutritious food. Overfishing can disrupt the economies of
coastal regions that depend on fishing for tourism and recreational activities. Declining fish
populations can lead to a decrease in tourism revenues, affecting businesses such as hotels,
restaurants, and recreational fishing charters.

Addressing the negative externalities of overfishing requires a

combination of sustainable fisheries management practices, conservation efforts, and
international cooperation:

 Implement science-based fisheries management strategies, including setting catch

limits, enforcing fishing regulations, and implementing measures such as size limits
and fishing quotas to ensure the sustainability of fish populations.
  Establish and effectively manage marine protected areas to conserve critical habitats,
spawning grounds, and biodiversity hotspots. These protected areas can serve as
fishery replenishment zones and help restore fish populations.
 Invest in research and development of innovative fishing practices and technologies
that minimize bycatch, improve selectivity, and reduce the environmental impact of
fishing activities.
8. Multidivisional firms:

Multidivisional firms are the firms that operate more than one
division. Their decision has huge impact on the firm’s employees and associated
stakeholders. It exerts both positive and negative externalities on the stakeholders.
Multidivisional firms aim to improve operational efficiencies by organizing different
divisions based on specific product lines, markets, or geographic regions. This structure
allows for specialization and the sharing of resources, knowledge, and best practices among
divisions. Positive externalities can arise when divisions within the firm benefit from
increased efficiency and productivity due to shared resources and expertise. The
multidivisional structure can lead to internal competition among divisions. While competition
can spur innovation and efficiency, gawithin the firm. However, cooperation can also emerge
when divisions collaborate to achieve common goals, leading to positive externalities such as
knowledge sharing and synergistic effects. The separation of ownership and control in
multidivisional firms can lead to agency problems. Divisions may have different incentives,
goals, and objectives that are not always aligned with those of the firm as a whole. Agency
costs can arise when divisional managers act in their self-interest, potentially leading to
suboptimal decisions, reduced coordination, and negative externalities on overall firm
performance.

To overcome the negative externalities of multidivisional firms, they

follow the following rules

 Managing the negative externalities of multidivisional firms requires effective

governance mechanisms, transparency, and strategic oversight.
 Measures to address these externalities include clear communication channels, robust
performance measurement systems, incentive alignment, and effective coordination
mechanisms across divisions.
  regulatory frameworks and antitrust policies can help mitigate negative externalities
related to market concentration and anti-competitive behavior.

9. Network Effects:

Network effect refers to any situation in which the value of a

product, service, or platform depends on the number of buyers, sellers, or users who leverage
it. Network effects occur when the value of a product or service increases as more people use
it, creating positive externalities. However, network effects can also result in negative
externalities.

As more users join a network or platform, it becomes more valuable for

existing users. This can occur through increased network size, improved connectivity, enhanced
communication, and access to a larger user base. Positive externalities arise when the presence of
additional users enhances the experience, functionality, and benefits of the network for all users.
Network effects can stimulate innovation and the development of new products, features, and
services. As the network grows, it attracts developers, entrepreneurs, and businesses who
create complementary products or services to leverage the network's user base. This leads to
positive externalities for users as they gain access to a wider range of offerings within the
network ecosystem. Ecosystem Effects: Network effects can lead to the creation of vibrant
ecosystems around the network or platform. Developers, content creators, and service
providers are incentivized to participate in the ecosystem and build complementary products
or services. This ecosystem growth benefits users by providing a diverse range of offerings
and fostering innovation.

Network effects can create lock-in effects, where users become dependent
on a particular network or platform due to the high switching costs associated with moving to an
alternative. This can limit user choice and reduce competition, leading to potential negative
externalities such as reduced innovation, lack of diversity, and potential exploitation by the dominant
network. Network effects often require users to share personal data, which can raise privacy
concerns. The widespread use of a network or platform increases the potential for data
breaches, unauthorized access, and misuse of personal information. These negative
externalities can result in compromised privacy and security for users. Strong network effects
can lead to monopolistic behavior by dominant network providers. This can result in anti-
competitive practices, such as exclusionary behavior, predatory pricing, or limiting
interoperability with other networks. These actions can harm competition, innovation, and
consumer welfare.

To overcome the negative externalities of network effect, some

policies must be adopted:

 Regulatory bodies can enforce antitrust laws and monitor the behavior of dominant
network providers to prevent anti-competitive practices, promote fair competition,
and protect consumer interests.
 Encouraging interoperability between different networks and platforms allows users
to connect and communicate across networks, reducing lock-in effects. Promoting
data portability empowers users to easily transfer their data between platforms,
increasing user choice and competition.
 Implementing robust privacy and data protection regulations helps safeguard user
privacy, ensure transparency in data practices, and protect against potential data
breaches and misuse.

Conclusion:

In conclusion, there are both positive and negative externalities exist

around us. The case study highlights the significant role of externalities in shaping various
aspects of economic activities and societal well-being. Externalities can be both positive and
negative, and their effects extend beyond the immediate participants to impact individuals,
communities, and the environment. By examining the specific case study, it becomes evident
that externalities can have profound consequences on different stakeholders. Understanding
and addressing these externalities is crucial for achieving sustainable and equitable outcomes.
Overall, these case studies emphasize the importance of recognizing and addressing
externalities for achieving sustainable development and promoting the well-being of
individuals, communities, and the environment. By implementing comprehensive strategies
and involving various stakeholders, we can strive for a more balanced and equitable outcome
that considers the positive externalities while mitigating the negative ones.