Question

Explain the concepts of externality and its classification.

Answer 1

Externalities refer to external effects or spillover effects resulting from the act of production or consumption on the third parties. Externalities arise due to interdependence between economic units.

Positive Consumption Externality: When some residents of a locality hire a private security agency to patrol their area, the other residents of the area also benefit from better security without bearing the cost.

Negative Production Externality: A person smoking cigarettes gets may give satisfaction to that person, but this act causes hardship (dissatisfaction) to the non – smokers who are driven to passive smoking.

Positive Production Externality:

• The ideal location for beehives is orchards (first growing fields).
• While bees make honey, they also help in the pollination of apple blossoms.
• The benefits accrue to both producers (honey as well as apple). This is called reciprocal untraded interdependency.
• Suppose training is given for the workers in a company. If those trained workers leave the. company to join some other company, the later company gets the benefit of skilled workers without incurring the cost of training.

Negative Production Externality: