Sunday, May 22, 2016


Externalities are a type of market failure that occurs when the costs or benefits of a good sold in a market are not entirely paid or received by the market participants. When this happens, the market fails to produce the best outcome for society. That is, the market fails to be efficient in the sense that total economic surplus is not maximized.

Negative externalities occur when someone other than the buyer or seller of a good incurs a cost when that good is produced or consumed. Many forms of pollution can be classified as generating negative externalities. If the pollution is unregulated (i.e. there is no government intervention into the market), then the market that produces the pollution is inefficient. 

When visualizing negative externalities from pollution, students often think of a factory emitting harmful substances from a smokestack, or an industrial agricultural facility creating water pollution from pesticide runoff. That is, we tend to conceptualize pollution externalities as the result of production (the supply side of the market), and place blame on "big corporations". 

But we must keep in mind that as consumers we are largely responsible for pollution impacts, because if we didn't demand those goods and services, they would not be produced. Here is a link to a story at EurekAlert regarding pollution from consumption. The main takeaway is that consumers are mostly responsible for pollution, albeit indirectly. Which country's citizens have the biggest impact via consumption?  Which products that you consume every day generate the most pollution? 

When we speak of "external costs", what types of costs are we talking about?  The first thing that comes to mind for me is loss of human health. Here is a story about the health effects of air pollution. The numbers are staggering. 

I'm often asked to comment on the idea that environmental regulations make the economy less productive. My reaction is typically that it's exactly the opposite. There is a vast amount of evidence suggesting that reducing air and water pollution can make the economy more productive, not less. 

Here is an article at The Atlantic outline the healthcare costs savings of the Clean Air Act. 

Here is a good description of the benefits of clean water from David Brodwin at US News.

Here is a brief outline of negative externalities associated with air pollution from transportation from Hofstra University. 

Here is some good background reading on negative externalities and public goods from the IMF.


Marc Monace said...

I can't help to think of China reading about externalaties. They have alot of the same regulations we do (although late and alot less rigorous) but still have more devastating effects in terms of pollution. Where is the disconnect?

Nicole Ruest said...

I found the EurekAlert article very interesting. When I think of consumerism my mind goes right to the average American. The majority of Americans have a "more is more" sort of attitude, and believe that having great "stuff" constitutes a successful life, so with household consumption accounting for 60-80% of environmental impacts (according to the article), it is no wonder that the US is so high on the list for countries with the biggest ecological footprints.

Asia Askew said...

An example that I can think of is that at one time bottled water was laughable but once it started selling in the markets, the demand for it greatly increased. More companies ended up competing with each other to produce bottled water causing harmful externalities from factories and also from people throwing the bottles away instead of recycling. The companies could have used a more efficient way to produce their products but if it wasn't for the demand in the first place, the externalities wouldn't have existed.

Ryan Grim said...

I think a large dam is a good example of creating externalities. The dam would create flood protection for people downstream from it but it may have been built to create a lake for a different community. The dam might also hurt downstream cities use of a river for fishing or irrigation. It would create both positive and negative externalities.

Haley Larabee said...

When I think of negative externalities I tend to think of pollution from big industry, and would typically direct the blame on them. But the consumer really does have a part to play in this, and simply cannot be left out of the equation. Consumers demand the products that essentially create this pollution; for example the demand for pork and the negative externalities that go along with pork production.

A few months ago I attended a lecture at one of the Sierra Club events here in Wilmington, and the woman speaking worked with an environmental justice organization primarily dealing with CAFO's in North Carolina. I learned a lot about how hog farmers are "dealing" with the waste (typically in unlilned lagoons, then later sprayed on fields as fertilizer) and how badly the people around these CAFOs are suffereing. Many of them suffered from respiratory problems, their water is in some cases not very clean, and they can't even stand to be outside of their house because the smell is just so bad. Often, these CAFOs are located in areas of low socioeconomic status.

I would like to think that if the public were more informed, maybe they would realize that their decision in the grocery store (or just in a market in general) has implications beyond the satisfaction of having that product.