Explain the difference between a positive and negative externality.

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In economic terms, an "externality" is something that has an economic effect on someone that is beyond their control and is not the result of their actions. If the externality is beneficial, we say that it is a positive externality. If it has a cost, then it is negative. If...

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In economic terms, an "externality" is something that has an economic effect on someone that is beyond their control and is not the result of their actions. If the externality is beneficial, we say that it is a positive externality. If it has a cost, then it is negative. If one owns a restaurant in a small town and a new factory opens up there, boosting the local economy, more people will likely come to the restaurant, and its owner will make more money. The food, decor, and service (all of which are within the owner's control) will be the same, but profits will be higher. This is a positive externality.

To continue the example, imagine that, after five years of operation, the factory closes because of a decision made at the corporate level. The owner of the restaurant, despite having made no changes, will probably see profits drop, as people move from the town or have less money to spend on dining out. Because the factory's decision to shut down was totally out of the restaurant owner's control, but still costs him or her money, it is understood to be a negative externality.

We can think of other examples of externalities related to the imaginary factory. For example, the factory might pollute a nearby river, causing increased health costs for residents and hurting the local sport fishing industry. These are negative externalities. At the same time, it might provide a sizable tax base which leads to more funds to support local schools. This is a positive externality.

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The difference between a positive externality and a negative externality is that the former has good effects on people while the latter has bad effects.

An externality occurs when an economic action takes place and has an effect on people who are not directly part of the action.  When an economic action takes place and other people are helped, it is a positive externality.  When other people are harmed by the economic action, it is a negative externality.

Let us look at an example of each of these.  For example, let us imagine that a landowner a half mile from my house decides to build a casino on their land.  I am not part of this economic action.  However, the action has an impact on me.  All of a sudden, there is a huge increase in traffic on my street at all hours of the day and night.  My quality of life is decreased.  This is an example of a negative externality.  Now let us imagine that this landowner makes a very large park instead of a casino.  Now, my kids can bike to the park and play.  There are more places to take walks.  I have gotten a benefit from something that I did not pay for.  This is a positive externality.

Externalities are impacts of economic actions that affect people who were not directly involved with those economic actions.  The difference between the two kinds that you mention is that negative externalities harm people while positive externalities are beneficial to them.  To see how this could be the case, let us look at an example of each type.

Negative externalities are much easier to imagine than positive ones.  The classic example of a negative externality is pollution.  Imagine that there is a large factory upwind of your home.  The factory is engaged in economic activity and you are not connected to that factory.   The economic activity at the factory creates pollution and the pollution drifts downwind and settles on and around your home.  It might make it hard for you to breathe.  It might make your house dirty.  In other words, it hurts you.  This is a negative externality.

Education is an example of an economic activity that has positive externalities.  If children in your town are educated, it helps everyone, even those who do not have children and are not part of the school system.  Educated children are less likely to grow up and commit crimes.  They will become better workers and might boost the economy of your town.  Everyone benefits from this even if they are not involved in educating the children.

Thus, externalities occur when an economic activity impacts people who are not involved in that activity.

 
 
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