Positive and Negative Externalities in the Market - Essay Example

A negative externality or external cost comes from third parties suffering costs or financial consequences following market transactions between other parties involved in the purchase and sale of goods & services. For instance, when an organization involved in the production or manufacture of goods for the market pollutes the environment through the release of harmful gasses into the environment, the general public may suffer diseases translating into medical expenses not anticipated. The recent economic crises which resulted from the crash of the banking and mortgage markets translated into escalated prices with financial consequences for the general public. On the other hand, a positive externality comes about when market transactions benefit third parties in a way. A good example is when a company invests in research & development which in the end benefits many other companies in the market.

In conclusion, therefore, externalities result in inefficiencies which may eventually lead to market failure i.e. private decisions which are based on the market fail to give efficient and desirable results from the perspective of the general welfare. The government, therefore, intervenes to address the inefficiencies and adverse market effects resulting from the externalities. In cases of negative externalities, the government can respond by imposing taxes on the involved parties which equal the amount of harm suffered by others. in response to positive externalities where social gains exceed private gains, the government can also intervene by subsidizing those generating the social gains with amounts equivalent to what others gain. Read More