Question

Consequences (benefits or costs) that are experiences by parties not directly related to the decision (Acid rain example), external parties not always factor into this decision. Solution is to force decision makers to incur the costs they would otherwise ignore. Can happen between corporation departments.

Answer 1

An externality occurs when an exchange between a buyer and seller affects a third party. It can have a negative or positive impact. In the case of negative externalities, parties causing harm should be accountable. In the case of positive externalities, compensation to those providing benefits would incentivize increased production.

Step-by-step explanation:

An externality occurs when an exchange between a buyer and seller has an impact on a third party who is not part of the exchange. An externality, which is sometimes also called a spillover, can have a negative or a positive impact on the third party. If those parties imposing a negative externality on others had to account for the broader social cost of their behavior, they would have an incentive to reduce the production of whatever is causing the negative externality. In the case of a positive externality, the third party obtains benefits from the exchange between a buyer and a seller, but they are not paying for these benefits. If this is the case, then markets would tend to under-produce output because suppliers are not aware of the additional demand from others. If the parties generating benefits to others would somehow receive compensation for these external benefits, they would have an incentive to increase production of whatever is causing the positive externality.