A negative externality is a cost that is suffered by a third party as a consequence of an economic transaction. In a transaction, the producer and consumer are the first and second parties, and third parties include any individual, organisation, property owner, or resource that is indirectly affected. Externalities are also referred to as spillover effects, and a negative externality is also referred to as an ‘external cost’.
What are the consequences of Negative externalities on society?
Negative externalities occur when the consumption or production of a good causes a harmful effect to a third party.
Examples of negative externalities
- Loud music. If you play loud music at night, your neighbour may not be able to sleep.
- Pollution. If you produce chemicals and cause pollution as a side effect, then local fishermen will not be able to catch fish. This loss of income will be the negative externality.
- Congestion. If you drive a car, it creates air pollution and contributes to congestion. These are both external costs imposed on other people who live in the city.
- Building a new road. If you build a new road, the external cost is the loss of a beautiful landscape which people can no longer enjoy.
Externalities will generally cause competitive markets to behave inefficiently from a social perspective. Externalities create a market failure—that is, a competitive market does not yield the socially efficient outcome. Education is viewed as creating an important positive externality.
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