ECON 20043 – BASIC ECONOMICS WITH TAXATION

1st Semester, School Year 2023-2024

Name: ABIANG, JENNIFER B.

Subject and Section: BSOA 4 - LADDERIZED
Date: January 6, 2024

1. What are externalities?

Externalities are the unintended costs or benefits of an economic activity that spill over
to third parties not directly involved in the transaction. They occur when the market price of a
good or service does not reflect the true costs or benefits to society.

2. What are the types of Externalities? Discuss each and give 2 examples each.
A. Negative Externalities:
• Production Externalities: These occur when the production of a good or service
imposes costs on others, such as pollution from a factory affecting nearby
residents.
Example 1: A chemical factory releases harmful fumes, causing respiratory
problems for residents in the surrounding area.
Example 2: An airplane emits noise pollution during takeoff and landing,
disrupting the peace for people living near the airport.

• Consumption Externalities: These occur when the consumption of a good or

service imposes costs on others, such as secondhand smoke from smoking
cigarettes.
Example 1: A person smokes cigarettes in a public space, exposing others to
secondhand smoke and potential health risks.
Example 2: Someone drives a loud motorbike through a quiet neighborhood,
disturbing the peace and enjoyment of residents.

B. Positive Externalities:
• Production Externalities: These occur when the production of a good or service
benefits others, such as vaccinations preventing the spread of diseases to non-
vaccinated individuals.
Example 1: A company invests in research and development, leading to new
technologies that benefit society as a whole.
Example 2: A farmer practices sustainable agriculture, improving soil quality and
benefiting future generations.

• Consumption Externalities: These occur when the consumption of a good or

service benefits others, such as education improving the knowledge and skills of
society.
Example 1: Someone volunteers at a local charity, providing valuable services to
the community.
Example 2: A person chooses to exercise regularly, improving their own health
and potentially inspiring others to do the same.
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 ECON 20043 – BASIC ECONOMICS WITH TAXATION
1st Semester, School Year 2023-2024

3. What are the advantages and disadvantages of the types of externalities.

A. Negative Externalities:
Advantages: None, as they lead to inefficient market outcomes and harm the well-being
of others.
Disadvantages:
• Cause economic inefficiency by underestimating the true cost of production or
consumption.
• Generate negative social impacts, such as pollution, noise, and health risks.
• Can lead to conflict and resentment between those causing and experiencing the
externalities.

B. Positive Externalities:
Advantages:
• Enhance social welfare by providing benefits to others beyond the producer or
consumer.
• Promote innovation and technological advancement.
• Create a more sustainable and healthier environment.
Disadvantages:
• Can lead to underproduction or underconsumption of the good or service if the
benefits are not fully accounted for.
• May create free-rider problems, where individuals benefit from the externality
without contributing to its production.
• Can be difficult to measure and value, making policy interventions challenging.

4. How can public policy resolve issues on externalities? Give 3 examples each.
• Negative Externalities:
1. Regulation and Standards: Setting limits on pollution, noise, and other harmful
externalities.
2. Pigouvian Taxes: Taxes levied on activities that generate negative externalities to
internalize the cost and discourage production.
3. Subsidies and Incentives: Encouraging activities that reduce negative
externalities or provide alternative solutions.

• Positive Externalities:
1. Direct Government Provision: Providing public goods and services that generate
positive externalities, such as education, healthcare, and infrastructure.
2. Subsidies and Incentives: Encouraging activities that generate positive
externalities, such as research and development, innovation, and volunteerism.
3. Property Rights and Coase-an Bargaining: Facilitating agreements between
individuals affected by externalities to negotiate mutually beneficial solutions.