Externalities (spillover effects) are common in virtually every area of economic activity. Externalities occur when firm or people impose costs or benefits outside the market place. External cost and benefits together are called externalities.
External cost are said to be the negative externalities and external benefits are said to be positive externalities. External cost is the uncompensated cost n individual or the firm imposes on the other; the best example for external cost or negative externalities is the environment cost of the pollution. The external benefits are the benefits the individual or firm gives to others without receiving any compensation in returns, the best example for positive externality or external benefit is the national defense provided to protect the freedom of everyone, even if one wants or not irrespective of whether one is paying for it or not and commodity available from public distribution system. The government should be more concerned about the negative externalities.
The government should be more concerned about the negative externalities. They are defined as third party effects arising from production and or consumption of goods and services for which no appropriate compensation is paid. The study of externalities by economists has been more in the recent years after the link between the economy and environment became strong.
Externalities create divergence between private and social cost, e.g. costs of pollution is not included in the cost of production of the factory, which is creating the pollution; but it is included in the social cost as the community has to bear the cost in some way or the other. Thus the social cost in this case is greater than the private cost.
Social cost = private cost + private cost
A chemical factory throwing out a lot of chemical waste in the nearby river killing the fish and making the water unhealthy for use, refineries pollute the air and paint industry creating bad odour, creating respiratory track infections and other diseases to all the people living in the area around the factories. These negative externalities will increase the social cost as the cost on the clean up and health will increase. External cost due to traffic jams, an individual deciding to go for a drive in the peak hours and increasing the travel time of the other drivers are all negative externalities.
We already have discussed about investment function and capital expenditure in our previous post. Now, the blog will discuss about all aspect of business and economics.
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