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Terms in this set (33)

These are the costs or benefits associated with the production or consumption of goods and services that are passed onto third parties or spill over to affect others. Externalities result in the production of social costs or social benefits faced by society more generally.
Externalities in production:
These are externalities that flow purely from the production of a good or service. A factory producing steel that allows its waste to flow down an adjacent river is an example of a negative externality. When taking its costs of production into account, it does not incorporate costs of polluting the river, sometimes referred to as social costs that are borne by the users of the river. In contrast, a business that invests in research and development (R&D) or training of its employees is seeking to derive benefits (i.e. profit) from their production. However, these activities will tend to confer benefits to third parties or society more generally, such as when trained employees move to a new employer or when the R&D leads to new technological inventions or advances, which improves the welfare of society in general.
Externalities on consumption:
These are externalities that flow purely from the consumption of a good or service. Whilst some externalities in consumption can be positive (such as education and gardening), most are negative. Examples include the external costs associated with the consumption of illicit drugs, alcohol, cigarettes, and some firearms. In a free a market, consumption of these goods and services (also referred to as de-merit goods) would be far greater than occurs currently.
Government correction:
• Government laws or legislation
• Using an indirect tax
• Using government cash subsidies
• Education and advertising to inform the public