• 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.


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