what are externalities and why are they so important in everyday life?


what are externalities and why are they so important in everyday life?

In: 14

It’s a catch all term for any variable that are not included in a given system. They are external to it.

Classic exemple, the “cost” to society of producing CO2 was never taken into account. It was free, “external” to the decision making process, so no one had any incentive to even monitor it, even less try to reduce it.

Compare to the cost of energy, that is “part” of the economic equation: all economic actors will try to optimize it or reduce it.

If you want an efficient market that take into account CO2, you need to make this externality, “internal” which is the goal of things like CO2 allocations and CO2 markets. That’s not that easy.

Impact on people outside the decision-making process. Can be positive or negative.

Classic example #1: If I choose to not mow my lawn, any neighbor trying to sell their house will have a difficult time, or have to sell at a lower price. In a system that catches all the impacts, they might pay me to keep my lawn mowed. But that is not how we do it. I choose to mow or not mow primarily on how it affects me.

Classic example #2: If a business can dump their waste products in a nearby stream without consequence, they have lower costs than if they had to dispose of it properly. They can make more widgets, sell at a lower price, and/or realize higher profits. But their free polluting affects all the people downstream that rely on or enjoy that waterway. We use regulations and fines to take those costs that were “external” to the companies cost/benefit calculation and move them “internal” to get decisions that are more socially efficient.

Basically, in economic policy, there are two main considerations: downstream effects, and externalities. The downstream effects are things that are direct consequences of actions. Externalities are in-direct consequences of actions. Both are usually fairly foreseeable but if something unforeseen happens it’s usually an externality rather than a downstream effect.

Using IDK, the biggest piece of legislation to date as an example, in many states where abortion is banned the direct consequences is a smaller labor pool, and more families dependent on the government for various things. This costs money.

A good example of an externality, from the same policy, is when large private businesses very publicly pull out of those states, because they cannot attract the required talent to function, who are also willing to move to those states due to their political inclinations. [Eli Lilly was in the news](https://fox59.com/indiana-news/eli-lilly-to-seek-employment-growth-outside-of-indiana-after-abortion-ban/) most recently for this. This is a loss of tax revenue which means there is less money to go around.

In Economics, an externality can be positive or negative.

A negative externality is a cost ascribed to a third party not included in a transaction. The common example is a chair factory selling to someone out of State. The Chair co.pany gets paid for the chair, the buyer gets a chair, but the town that lives next to the river where the chair factory dumps it’s toxic chemicals ALSO suffers the negative result of this transaction, even though they didn’t buy any chairs.

For the factory, they get to shunt the expenses of the externality to other people, so they can produce the chairs for cheaper than ordinarily possible.

In a market economy like the US, it is the governments job to force companies to internalize the costs of their business practices. They do this by illegalizing the pollution. If the government does not do this, the market system does not work efficiently and we wind up with poisoned air and water.

The reverse is true for positive externalities. The government should subsidize positive externalities, otherwise the artificially high price will reduce the amount of the product that has a positive externality.

“Externalities” are side effects your economic activity creates that impose costs or problems on someone else or society at large.

Most commonly this refers to things like pollution or CO2 emissions. The river may be a cheap place for your factory to dump toxic waste, but everyone who uses the river is affected by the ruined water supply and ecological damage. Gasoline cars, trucks and planes are convenient for getting you and your stuff from point A to point B, but they put CO2 into the atmosphere and increase global temperature.

These kinds of things are frequently the subject of government regulation, either to ban the externality producing activity outright (make it illegal for factories to dump toxic waste in the river), or to make people pay to have the externality removed (a tax on cars or gasoline that’s used to pay for planting trees or other CO2 reducing activity).