Economics: Externalities

Difficulty: 2/3 (Graphs are a bit hard to grasp, other than that, easy concepts)
Review: 4/5 (Externalities are reviewed well in this chapter, but graphs are not explained as well)

We return to the Ten Principles of Economics for this chapter, where we discuss how externalities cause market failure. An externality, whether positive or negative, is when the market doesn't take into account the affects of transactions on bystanders. An example of a negative externality is like pollution, and a positive one is technology spillover.

Since externalities cause market failures, there has to be solutions. One type of solution is the private solution, where people trade or make contracts, as stated in the Coase theorem to satisfy each other. This doesn't always work due to transaction costs (translators, lawyers, etc.)

The government can also make solutions. There can be Command-and-Control by regulation, like only allowing a certain amount of pollution to be legal. There's also Market-Based like using corrective taxes/subsidies, so parties get to decide what is efficient to them for a price. Another Market-Based policy is permits, where people trade rights to continue these externalities, e.g. tradable pollution permits.

All in all, a free market sometimes will not work out due to these externalities. Fortunately, suppliers, consumers, and the government can help to solve them.