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Externalities influence the market failure
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Externalities
610 Words2 Pages
Recommended: Externalities influence the market failure
What are externalities?
Externalities are common in virtually every area of economic activity.
They are defined asthird party (or spill-over) effects arising from
the production and/or consumption of goods and services for which no
appropriate compensation is paid.
Externalities can cause market failure if the price mechanism does not
take into account the full social costs and social benefits of
production and consumption.
The study of externalities by economists has become extensive in
recent years - not least because of concerns about the link between
the economy and the environment.
PRIVATE AND SOCIAL COSTS
Externalities create a divergence between the private and social costs
of production.
Social cost includes all the costs of production of the output of a
particular good or service. We include the third party (external)
costs arising, for example, from pollution of the atmosphere.
SOCIAL COST = PRIVATE COST + EXTERNALITY
For example: - a chemical factory emits wastage as a by-product into
nearby rivers and into the atmosphere. This creates ne...
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