Assignment 2: Externalities
ECO 405
Prof Bergan
August 11, 2013

An externality is something that, while it does not monetarily affect the producer of a good, does influence the standard of living of society as a whole (Kelly, Krugman, & Robin, 2008 ).There are two types of externalities positive and negative both play important roles in our everyday living. When there is a cost of externality than that is considered negative and when there is a benefit of an externality it is considered a positive externality. Positive externality is defined as benefits that accrue to third parties not involved in an economic activity. These benefits can be passed on due to either the consumption or production of a commodity by society (Kelly, Krugman, & Robin, 2008 ). Negative externalities are costs that third parties have to bear when a good is consumed or produced.
Environmental cleanup can be considered as positive externalities. When the environment is clean we all benefit as a society but do not increase profits for the company responsible for it. Likewise, research and new technological developments create gains on which the company responsible for them cannot fully capitalize. Another positive externality is education when people are getting a better education this is a benefit for the country as a whole as more foreign direct investments will flow into the country. This will definitely increase employment and income for people who can’t find a job. Immunizations, such as a flu shot, etc., provide a positive externality to third parties in that it helps prevent the spread of illness in the general public.
Negative externalities, unfortunately, are much more common. Pollution is a very common negative externality. A company that pollutes loses no money in doing so, but society must pay heavily to take care of the problem pollution caused. Pollution from a factory can cause health problems and erode the quality of life and property values in a community. There are many kinds of pollution air, water and land. Air pollution from burning fossil fuels causes damages to crops, buildings and public health. Water pollution by industries that adds poisons to the water, which harm plants, animals, and humans. Noise pollution is mentally and psychologically disruptive (Kelly, Krugman, & Robin, 2008 ).
An externality might exist when a person engages in an activity that influences the well-being of bystander and yet neither pays nor receive payment for that effect. In pollution the producer and consumer finance the goods produced but society must bear the cost of pollution that is introduced into the environment as a byproduct and is thus a negative externality (Kelly, Krugman, & Robin, 2008). When the factory bear the cost the remaining cost is borne on society to take care of. Say for example that I decide to start an organic rosemary farm in my backyard and that the smell is so strong that my neighbors find it so unpleasant that they want me to stop. They can't sleep at night and one of the adults has started to get headaches from it. So, here we have a situation in which I do something because it provides me with benefit--rosemary is my favorite spice, I can give it as a gift to people and sell it to food retailers and restaurants. Everyone is getting mad at each other. They are mad at me for having the farm and I am mad that they keep on complaining. If rights are clearly assigned and there are no transaction costs from seeking enforcement, the situation can be resolved in the following manner. Let’s say I derive X in Utility from the Farm and my neighbors derive Y in disutility from the farm. If I have a right to have a rosemary farm in my backyard, and X>Y, I continue to farm and tough luck for the other guys because they might be bothered but they won't be willing to pay me X for the misery I have caused them because that misery is less than X.If I have a right to have a rosemary farm in my backyard, and X<Y, They can pay me somewhere between X and Y to stop... and I will gladly do so as I would at the very least break even and I might even make a bit of a profit. If they have the right to a smell-free environment, and X>Y, I can offer them an amount of compensation that is between Y and X to let me farm and they will take it because it would be more than the harm they receive. If they have the right to a smell-free environment, and X<Y, tough for me, they won't take any less than Y and I am not willing to pay more than X.
Another way to solve the negative externality problem is to simply tax the producer the amount of the negative externality. This adds to the producers marginal cost and will cause them to reduce output. It is possible for the government to control many types of pollution by placing taxes on polluting activities. Where the amounts of polluting discharge can be measured for individual polluters, a tax can be placed directly on each unit of discharge (Grimes, Register, & Sharp, 2013). It is necessary for government to regulate and introduce these taxes and legislation to address this situation of pollution. The government addressed these issues also with the Clean Air Act.
The government and the stakeholders are some of the parties that are affected and also involved in the externality because since the negative externality is a cost that is not accounted for by the market than part of that cost is transferred to a stakeholder that is not involved in the transaction. These stakeholders include society or government, the environment and workers in any phase of production. Organic, local, humane, and environmentally friendly options may go some way to internalizing the costs which are often pushed onto the environment and government.
The government, stakeholders, society and even the Environmental Protection Agency all play important roles in the regard to the externality. Government agencies, notably the Environmental Protection Agency (EPA) at the federal level, often use direct control to reduce many kinds of polluting activities (Grimes, Register, & Sharp, 2013). The government role is to intervene and to make sure that they reduce the market failure from negative externalities. If the government subsidize goods can service that will definitely generate a spillover benefit and it will help with encouraging a positive externalities. Government can play a role in reducing negative externalities by taxing goods when their production generates spillover costs. This taxation effectively increases the cost of producing such goods (Kelly, Krugman, & Robin, 2008 ).

Works Cited
Grimes, P. W., Register, C. A., & Sharp, A. M. (2013). Economics of Social Issues. McGraw-Hill Learning.
Kelly, E., Krugman, P., & Robin, W. ( 2008 ). Study Guide for Microeconomics. Macmillan.