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or benefits of a transaction
to parties who do not directly participate in it. Externality can be either positive or negative. For example, a merger
can lead to higher share prices and bonuses
for employees, benefiting shareholders
at the two companies merging, This can create wealth
and positively impact a community. On the other hand, the merger can drive a competitor out of business, which results in layoffs
and reduced wealth, which can hurt a community. Externality is also called spillover or the neighborhood effect. See also: External benefit
, External cost
externalities factors which may result in a benefit or cost to a firm or society which originate, in part, from outside the firm or as an adjunct to productive activity. A firm which does not itself invest in training its labour force, for example, may nonetheless benefit from being able to attract employees who have been trained by other firms or by the government. POLLUTION is an example of an external cost imposed on society: a chemical company which pollutes the air or contaminates river water incurs only the immediate costs of producing its products, while society suffers the extra costs of cleaning up the atmosphere and river.
externalities factors that are not included in GROSS NATIONAL PRODUCT but have an effect on human welfare. POLLUTION is a prime example of an external cost imposed on society: national output may only be maintained by allowing a certain degree of pollution, which detracts from the quality of life. A firm will include the PRIVATE COSTS of materials, labour and capital used in producing goods and services but will not count the SOCIAL COSTS of any pollution involved. ENVIRONMENTAL TAX can be used to counter pollution externalities by ensuring that customers pay prices for products that fully reflect the environmental costs involved in their production and consumption. On the other hand, positive externalities, such as the social benefits conferred by firms in training workers who become available for employment elsewhere, are again not counted in national output.
See MARKET FAILURE, ROAD CONGESTION, WELFARE ECONOMICS, COST-BENEFIT ANALYSIS.