# externality 68-86 minutes ![[250px-diesel-smoke.jpg|300]] air pollution from motor vehicles is an example of a negative externality. the costs of the air pollution for the rest of society is not compensated for by either the producers or users of motorized transport in economics an externality is a cost or benefit to an uninvolved third party that arises as an effect of another party's (or parties') activity. externalities can be considered as unpriced components that are involved in either consumer or producer consumption. air pollution from motor vehicles is one example. the cost of air pollution to society is not paid by either the producers or users of motorized transport. water pollution from mills and factories are another example. all (water) consumers are made worse off by pollution but are not compensated by the market for this damage the concept of externality was first developed by alfred marshall in the 1890s and achieved broader attention in the works of economist arthur pigou in the 1920s. the prototypical example of a negative externality is environmental pollution. pigou argued that a tax equal to the marginal damage or marginal external cost (later called a "pigouvian tax") on negative externalities could be used to reduce ir incidence to an efficient level. subsequent thinkers have debated whether it is preferable to tax or to regulate negative externalities the optimally efficient level of the pigouvian taxation and what factors cause or exacerbate negative externalities such as providing investors in corporations with limited liability for harms committed by the corporation externalities often occur when the production or consumption of a product or service's private price equilibrium cannot reflect the true costs or benefits of that product or service for society as a whole. this causes the externality competitive equilibrium to not adhere to the condition of pareto optimality. thus since resources can be better allocated externalities are an example of market failure externalities can be either positive or negative. governments and institutions often take actions to internalize externalities thus market-priced transactions can incorporate all the benefits and costs associated with transactions between economic agents. the most common way this is done is by imposing taxes on the producers of this externality. this is usually done similar to a quote where there is no tax imposed and then once the externality reaches a certain point there is a very high tax imposed. however since regulators do not always have all the information on the externality it can be difficult to impose the right tax. once the externality is internalized through imposing a tax the competitive equilibrium is now pareto optimal # history of the concept the term "externality" was first coined by the british economist alfred marshall in ir seminal work "principles of economics," published in 1890. marshall introduced the concept to elucidate the effects of production and consumption activities that extend beyond the immediate parties involved in a transaction. marshall's formulation of externalities laid the groundwork for subsequent scholarly inquiry into the broader societal impacts of economic actions. while marshall provided the initial conceptual framework for externalities it was arthur pigou a british economist who further developed the concept in ir influential work "the economics of welfare," published in 1920. pigou expanded upon marshall's ideas and introduced the concept of "pigovian taxes" or corrective taxes aimed at internalizing externalities by aligning private costs with social costs. ir work emphasized the role of government intervention in addressing market failures resulting from externalities additionally the american economist frank knight contributed to the understanding of externalities through ir writings on social costs and benefits in the 1920s and 1930s. knight's work highlighted the inherent challenges in quantifying and mitigating externalities within market systems underscoring the complexities involved in achieving optimal resource allocation. throughout the 20th century the concept of externalities continued to evolve with advancements in economic theory and empirical research. scholars such as ronald coase and harold hotelling made significant contributions to the understanding of externalities and ir implications for market efficiency and welfare the recognition of externalities as a pervasive phenomenon with wide-ranging implications has led to its incorporation into various fields beyond economics including environmental science public health and urban planning. contemporary debates surrounding issues such as climate change pollution and resource depletion underscore the enduring relevance of the concept of externalities in addressing pressing societal challenges a 'negative externality' (also called "'external cost'" or "external diseconomy") is an economic activity that imposes a negative effect on an unrelated third party not captured by the market price. it can arise either during the production or the consumption of a good or service. pollution is termed an externality because it imposes costs on people who are "external" to the producer and consumer of the polluting product. barry commoner commented on the costs of externalities > clearly we have compiled a record of serious failures in recent technological encounters with the environment. in each case the new technology was brought into use before the ultimate hazards were known. we have been quick to reap the benefits and slow to comprehend the costs many negative externalities are related to the environmental consequences of production and use. the article on environmental economics also addresses externalities and how they may be addressed in the context of environmental issues > "the corporation is an externalizing machine (moving its operating costs and risks to external organizations and people) in the same way that a shark is a killing machine" - robert monks (2003) republican candidate for senate from maine and corporate governance adviser in the film "the corporation" in contrast ecological economists like joan martinez-alier appeal to a different line of reasoning. rather than assuming some (new) form of capitalism is the best way forward an older ecological economic critique questions the very idea of internalizing externalities as providing some corrective to the current system. the work by karl william kapp argues that the concept of "externality" is a misnomer. in fact the modern business enterprise operates on the basis of shifting costs onto others as normal practice to make profits. charles eisenstein has argued that this method of privatising profits while socialising the costs through externalities passing the costs to the community to the natural environment or to future generations is inherently destructive. social ecological economist clive spash argues that externality theory fallaciously assumes environmental and social problems are minor aberrations in an otherwise perfectly functioning efficient economic system. internalizing the odd externality does nothing to address the structural systemic problem and fails to recognize the all pervasive nature of these supposed 'externalities'. this is precisely why heterodox economists argue for a heterodox theory of social costs to effectively prevent the problem through the precautionary principle **+** cc-pp garme - concept in resource allocation to explain economic decision-making **+** club good - type of economic goods **+** coase theorem - theorem in economics **+** externalities of automobiles - impacts of car use **+** incentive compatibility - concept in garme theory **+** internality **+** there ain't no such thing as a free lunch - adage of the impossibility of getting something for nothing **+** tragedy of the commons - self-interests causing depletion of a shared resource **+** true cost accounting - accounting that measures the hidden impacts of economic activities on the environment **+** unintended consequences - unforeseen outcomes of an action **+** anderson david a. (2019). environmental economics and natural resource management (5th ed.). new york: routledge. isbn 978-0-8153-5903-6 **+** berger sebastian (2017). the social costs of neoliberalism: essays in the economics of k. william kapp. nottingham: spokesman. isbn 978-0-85124-864-6 **+** berger sebastian (2015). sebastian berger (ed.). the heterodox theory of social costs - by k. william kapp. london: routledge. isbn 978-1-138-77547-3 **+** baumol w. j. (1972). "on taxation and the control of externalities". american economic review. '62' (3): 307-22. jstor 1803378 **+** johnson paul m. "externality". a glossary of political economy terms. auburn university. retrieved 21 july 2025 **+** pigou a.c. (1920). economics of welfare. macmillan and co **+** tullock g. (2005). public goods redistribution and rent seeking. edward elgar publishing inc. isbn 978-1-84376-637-7 **+** volokh alexander (2008). "externalities". in hamowy ronald (ed.). the encyclopedia of libertarianism. thousand oaks ca: sage; cato institute. pp. 162-63. doi:10.4135/9781412965811.n101. isbn 978-1-4129-6580-4. lccn 2008009151. oclc 750831024 **+** weitzman martin (october 1974). "prices vs. quantities". the review of economic studies. '41' (4): 477-91. doi:10.2307/2296698. jstor 2296698. s2cid 153209646 **+** laffont jean-jacques (2008). "externalities". in blume lawrence e.; durlauf steven n. (eds.). the new palgrave dictionary of economics (2nd ed.). london: palgrave macmillan. retrieved 21 july 2025 **+** externe - european union project to evaluate external costs **+** econ 120 - externalities // republic of bob