• See definition and ‘examples’

Costs and Benefits

  • Economists are interested in externalities because of the various costs and benefits that arise out of the actions of others
  • There are 3 types of costs and benefits:
  • Private Costs and Private Benefits
    • There are experienced by the people who are directly involved in the decision to take a particular action
  • External Costs and External Benefits
    • These are a consequence of externalities that arise from a particular action
    • They fall on third parties instead of those responsible for the action
  • Social Costs and Social Benefits
    • These are the total costs and benefits to society as a result of a particular action
    • By definition, they consist of private costs and benefits and any external costs and benefits that arise
  • A problem therefore arises when the private costs or benefits do not equal the social costs or benefits
  • The external costs or benefit distort the efficiency allocation of resources
  • It is for this reason that the market fails to produce the best allocation of resources

Negative Externalities

  • There are several cases where negative externalities may exist
  • This means that there are costs imposed on a third party over and above the costs directly paid for by those who carry out the activity
  • See example table

Positive Externalities

  • Examples of positive externalities are not as obvious or common as instances of negative externalities
  • As a consequence of positive externalities, the benefits received by a third part are over and above those that are received by the people who carried out the activity.