Externalities - Definition and examples

An externality arises when a firm or person engages in an activity that affects the well-being of a third party, yet neither pays nor receives any compensation for that effect. If the impact on the third party is adverse, it is called a negative   externality.

The following graph shows the demand and supply curves for a good with this type of externality. The dashed drop lines on the graph reflect the market equilibrium price and quantity for this good.

Shift one or both of the curves to reflect the presence of the externality. If the social cost of producing the good is not equal to the private cost, then you should shift the supply curve to reflect the social costs of producing the good; similarly, if the social value of producing the good is not equal to the private value, then you should shift the demand curve to reflect the social value of consuming the good.

Demand Supply PRICE (Dollars per unit) QUANTITY (Units) Demand Supply  

With this type of externality, in the absence of government intervention, the market equilibrium quantity produced will be   than the socially optimal quantity.

Which of the following generate the type of externality previously described? Check all that apply.

Your roommate, Simone, has bought a cat to which you are allergic.

Edison has planted several trees in his backyard that increase the beauty of the neighborhood, especially during the fall foliage season.

The city where you live has turned the publicly owned land next to your house into a park, causing trash dropped by park visitors to pile up in your backyard.

A leading electronics manufacturer has discovered a new technology that dramatically improves the picture quality of plasma televisions. Firms of all brands have free access to this technology.