As explained by the video (FRBSL, 2021), an externality is a term used in
economics to describe when a benefit or cost of a transaction is experienced by
someone who was not part of the transaction. Negative externalities occur when an
uninvolved party suffers a cost, while positive externalities are when they gain a benefit.
Therefore, a neighbor causing noise pollution by loudly playing music would be an example
of a negative externality because their neighbors are suffering a cost.
In this case the Coase Theorem would probably not be of much help in solving the
externality, although it is possible. The Coase Theorem states that if property rights are
well defined and transaction costs are low, resources will be applied to the most
efficient use. Hypothetically, the neighbors could demand that the noisy neighbor pay for the
right to play loud music. In reality however, the noisy neighbor likely does not have the right
to disrupt the peace in the first place and so has no position to bargain from. A simple noise
complaint filed to the police from any of the neighbors would solve the externality.
I recently experienced a positive externality at my place of work. The man I work for
bought supplies to produce a food product. After the products were finished and fully
prepared, there were left over resources that no longer had a use. Not wanting the
ingredients to go to waste, he allowed me to take the leftover ingredients home for my own
use. I gained a benefit without having to pay the cost or be involved in the original
exchange (a positive externality).
The current pandemic makes for an excellent example in positive externalities.
Wearing masks and getting vaccinated undeniably results in positive externalities for society
as a whole. As people take precautions to protect themselves, they also reduce the chances
of other people getting sick and dying. This can even go a degree further; by reducing their
chances of going to the hospital for COVID-19 they leave more beds for people needing
treatment for other health issues.
Even with these obvious benefits there is a lot of debate over whether or not the
government should get involved, and to what degree. The government has the unique
authority to assign property rights. Property rights (the exclusive right to decide how a
resource is used) have a very large impact on how externalities are handled. Because of
this singular authority many people believe it is the obligation of the government to intervene,
since no individual can do so as effectively. The federal government has been more
aggressively pushing people to get vaccinated recently, which I believe is a good thing. One
of the ways they encouraged this from the beginning was by keeping transaction costs, the
costs of completing a transaction, low by making the vaccine free for those without
insurance.
I am glad we have learned about the concept of externalities. I was unfamiliar with
these ideas previously but now I am confident that I understand them. My new knowledge will
be useful in my perception of market interactions in the future, and I will have a deeper
understanding of the world around me.
References
Federal Reserve Bank of St. Louis. (2021, April 23). Externalities, economic LOWDOWN
VIDEOS: Education: St. Louis Fed. Externalities, Economic Lowdown Videos |
Education | St. Louis Fed. Retrieved September 20, 2021, from
https://www.stlouisfed.org/education/economic-lowdown-video-series/episode-5-
externalities.
