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Externalities (external effects) in the economy reflect the impact of market transactions to third parties, not mediated by the market. This term was coined in 1920 by Arthur Pigou in his book “Theory of prosperity.” In the presence of externalities the market equilibrium ceases to be effective: there is a “Deadweight Loss”, violated Pareto efficiency, that is, there is market failure.
The main parameters of the economic theory are:
- Limiting private benefit of consumption – the demand for;
- Marginal private cost of consumption – supply of goods;
- Limiting the gain of society – the demand for goods, taking into account externalities;
- Marginal costs to society – a proposal for the goods, taking into account externalities;
Marginal costs and benefits of society are external and are usually not taken into account by the market.Â In the absence of external effects, the marginal cost / benefit of society are equivalent to the marginal private cost / winnings, respectively.
Types of externalities. There are two types of externalities: positive, in which the utility for the agents and their profits are not involved in the transaction, increase, and negative, leading to a reduction of utility or profit of others.Â Externalities are considered as part of the manufacturer, and from the consumer. Separation of the external effects on the negative and positive is fundamental, becauseÂ describes the effects on the subjects.Â But in the modern economic literature there are ttempts to clarify and refine this approach by providing new criteria for the analysis of external effects.
According to the results impact on the subject is negative and positive.
By Area of:
- Production – the economic activity of entrepreneurs-Chairman affect the level of production of other entrepreneurs;
- Consumer – the consumer economic activity affects the utility level of another consumer;
- Mixed (production-consumption – economic activity affects the entrepreneur’s utility level of the household, consumption-production – the economic activity of the household affects the level of production of entrepreneurs).Â By the nature of the impact on the subject:
- Technological – the consequences of economic activity, which are not covered by market processes;
- Cash – the result of the interdependence of producers (consumers), in which earnings depend not only on its own input and output, but production costs and other subjects.
By their impact on the subject:
- Limit – effects that a small change in the activity of creating the effect of the subject lead to significant changes in performance or utility of another entity;
- Intra marginal – effects that do not affect the use or performance of perceiving their subjects.
The effect on the welfare of others:
- Pareto-consistent – lead to the economic advancement of the subject without deterioration of others;
- Pareto-controversial – lead to real changes in the utility function or production function of the subject.
According to the method of transformation of external effects are:
- Eliminated by government regulation;
Positive externalities. A classic example of positive externalities from the manufacturer is the interaction of adjacent apple orchard and apiary: bee promotes crop of apples and apple trees – an increase in the collection of honey, while their owners do not come together in any market economy.Â Thus, the marginal private costs equal marginal cost society by the way, down that, in order to achieve market efficiency would cause a price reduction and increased product release under the influence of positive externalities.
Effect of positive externalities from the consumer is the ultimate growth of the private consumer gain, is also equivalent to limiting the gain of society.Â In this case, it would be best to increase the amount of the product, but make it pay for consumers.Â This kind of externality is often associated with “free-rider effect”, that is when the consumer does not pay for the use of the goods or services, provided that the manufacturer has invested in their production.Â Creator of positive externalities include, for example, a resident of the house that created the lighting in your entryway to the private interests that, at the same time, benefit neighbors domu.Otritsatelnye externalities
Negative externality from the manufacturer increases the value of the marginal cost of society.Â For example such an externality is pollution by industrial enterprises, where the increase of sales as a result of increased production wrapped damage to the environment, which suffer from some firms and society as a whole.Â Negative externality on the part of consumers reduces the value of the limit of private gain (as well as limiting payoff of society).Â A similar example: traffic jams.Â In this case, the motorists themselves create a negative externality, and pay for it your time.
Negative externalities are often resolved through government intervention in the economy.Â A State may establish different types of taxes, fees for “wreckers”.Â With an increase in taxes the company cut its product offer, while raising the price on it.Â In the case of congestion the government may make this route a fee.Â Social loss from wasting time are replaced by the cost of tax payments for the use of the road, but the public benefit will increase the value of winning the state from tax revenues, besides the road will certainly be much more unloaded.
Externalities can be in:
Consumption: When the consumption decisions of an agent affect the utility of another agent.Â Can be positive or negative.Â It is negative if, for example, our neighbor heard music during the night affecting our dream and our right to sleep.Â Is positive in the case where we enjoy the music because we love.
Production, when production decisions of a company affect the production possibilities of another company.
Consumption and production: When, for instance, production decisions of a company affects the utility level that reaches a consumer.
Externalities, also called economies (or diseconomies) external, whose effects can be positive or negative – in terms of costs or benefits – generated by the activities of production or consumption carried out by an economic agent and reach the other agents, without incentivesÂ economic causes for their produce or consume the amount relating to the social opportunity cost.Â In the presence of externalities, the social opportunity cost of a good or service is different from the private opportunity cost, so that there is no incentive efficient social point of view.Â So, externalities refer to the impact of a decision on those who participated in this decision.
The externality can be negative when it generates costs for the other agents – for example, a factory that pollutes the air, affecting the nearby community.Â May be positive, while the other agents, unwittingly, benefit, such as government investment in infrastructure and public facilities.
Coase (1960) argued that externalities exist due to lack of market and property rights are well defined.Â For example, in the case of water pollution, because neither industry nor the community holds the water being polluted and therefore lack a market: the market for pollution.Â In this market some agents are willing to pay to see the amount of production of pollution reduced, say, the pollution would have a price.Â If pollution from industry infers a cost to residents who live near it.Â Internalize this externality means include the cost caused by pollution so that it will enjoy the results of its production.But who pays?Â If the industry have the legal right to pollute the river, the community may be willing to pay to install a filter that reduces emissions.Â The principle adopted is usually the “user pays” principle, ie, polluters, or make indirect use of the pollution, pay for the external costs caused to others.
It is therefore possible that externalities will be overcome and eliminated without the presence of the state, provided that transaction costs are low.Â However, sometimes this occurs, giving rise to the state intervene in cases of externality.
Normally, the State has to create or encourage the installation of activities that constitute positive externalities (such as education), and prevent or inhibit the generation of negative externalities.Â This can be done through instruments such as taxation and legal penalties or, conversely, tax breaks and subsidies as appropriate.
Asymmetric information can cause an externality is not perceived, as is the case of products that produce negative externalities in their production processes while their consumers do not know, making purchasing decisions are made that would not be taken if there was complete information.Â To overcome these problems, environmental certification schemes are efficient options for consumers to internalize externalities produced by its consumption.
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