External Effect (Externality) Definition
An external effect, also known as an externality, arises when an individual's action results in a cost or benefit for others, and this impact is not factored into the decision-making process of the individual causing it.
0
1
Tags
Economics
Economy
Introduction to Microeconomics Course
CORE Econ
Social Science
Empirical Science
Science
Related
Condition for Market Efficiency: Complete Contracts
A large-scale bakery operates in a competitive market, selling bread to local consumers. The bakery's ovens release a pleasant aroma that significantly increases the foot traffic and sales for a neighboring café. The café owner does not pay the bakery for this benefit. Assuming the bread market is in equilibrium, which statement best analyzes this situation from an efficiency standpoint?
Market Efficiency and External Effects
Explaining Inefficiency from External Effects
A chemical factory operates in a perfectly competitive market and produces at a level where its private marginal cost equals the market price. If the factory's production process pollutes a nearby river, harming the local fishing industry, the market outcome is still considered Pareto efficient because the factory itself is operating at its profit-maximizing equilibrium.
Evaluating Market Outcomes with Positive Externalities
Match each market scenario with the most accurate description of its efficiency, considering only the information provided.
Analyzing Reciprocal Externalities
For a competitive market outcome to be considered Pareto efficient, the economic activities of buyers and sellers must not create significant, uncompensated effects on third parties. These effects are known as ____.
An economist is analyzing a competitive market for a product whose manufacturing process creates a side effect for people who are not involved in buying or selling the product. Arrange the following steps in the logical order the economist would follow to determine if the market's outcome is Pareto efficient.
A company manufactures fertilizer in a competitive market. The production process releases chemical runoff into a local river, which negatively impacts the downstream fishing industry. The company does not compensate the fishing industry for this damage. In this market, the equilibrium quantity is determined where the private marginal cost of production equals the price. How does this market equilibrium quantity compare to the Pareto efficient quantity?
External Effect (Externality) Definition
Price Signals in Markets With and Without Externalities
Learn After
Example of External Effects in Bread Production
Which of the following scenarios best illustrates an external effect?
Analyzing an External Effect
A chemical factory releases unfiltered smoke into the atmosphere, which causes respiratory problems for residents in a nearby town. The factory pays a government-mandated tax for every ton of smoke it releases. This situation is an example of an external effect.
Identifying External Effects in a Market Scenario
Match each scenario with the economic concept it best represents by identifying whether an external effect is present and its nature.
When a cost or benefit of an economic activity is experienced by someone who is not the producer or the consumer, and this impact is not reflected in the market transaction, this phenomenon is known as a(n) ____.
A new public park is built in a residential neighborhood. As a result, the property values of adjacent homes increase significantly. The homeowners did not contribute to the park's funding. Which statement provides the most accurate economic analysis of this situation?
An external effect occurs when an economic activity imposes a cost or benefit on a third party not directly involved in the transaction, and this impact is not reflected in market prices. Which of the following situations does NOT describe an external effect?
Externalities in an Urban Environment
Evaluating a Solution to an External Effect
An action is said to have an external effect when its impact on a third party is not considered in the economic decision-making of the person or firm causing the effect. In which of the following scenarios is the effect on the third party NOT considered an external effect in the economic sense?
Identifying External Effects in a Market Scenario