What Are Production Externalities?
Production externalities refer to unintended side effects resulting from industrial operations, such as a paper mill producing waste that is dumped into a river. These side effects are usually unintended and their impacts are often unrelated to and unsolicited by anyone. Production externalities can have economic, social, or environmental side effects.
Production externalities can be assessed by comparing the actual cost of production with the real cost to society at large. Their impacts can be positive or negative, or a combination of both.
Key Takeaways
- Production Externalities: They represent side effects from industrial operations, such as chemical companies leaking improperly stored chemicals into the water table.
- Measurement: Evaluated by the difference between the actual production cost and the real societal cost.
- Impact: These externalities can have positive, negative, or both types of impacts.
- Examples: They range from pollution to the depletion of natural resources.
The Broad Impact of Production Externalities
Practical Examples
There are numerous examples of production externalities, such as pollution and the depletion of natural resources. For instance, a logging company might pay for the cost of a tree they remove, yet the broader expense of replacing an entire forest far exceeds the sum of the lost trees. Other examples include freeway traffic jams and health challenges from breathing secondhand smoke, as seen in crises like Flint’s water contamination.
Historical Context
British economist A. C. Pigou was among the first to point out production externalities within systemic phenomena. According to Pigou, externalities prevent achieving Pareto optimality even under perfect competition. In the presence of externalities, the resulting social benefits or costs represent a combination of private and external outcomes.
Bright Side: Positive Production Externalities
A positive production externality, also termed an “external benefit” or “beneficial externality,” imposes advantageous effects on unrelated third parties. For example, consider a farmer who keeps bees for honey. These bees help pollinate nearby crops—a side effect possibly more valuable than the honey itself.
Additional Examples
- The construction of an airport, which boosts local businesses due to increased access.
- Industrial firms offering first aid classes to employees, thereby enhancing safety even beyond the workplace.
- Foreign firms showcasing modern technologies to local companies, thereby boosting their productivity.
Dark Side: Negative Production Externalities
Conversely, negative production externalities impose unfavorable effects on unrelated third parties.
Additional Examples
- Noise pollution from loud music in an apartment complex, resulting in a neighbor’s sleep deprivation.
- Increased use of antibiotics, leading to a rise in antibiotic-resistant infections.
- Health issues like early-onset Type II diabetes due to over-processing foods—in particular, fiber removal and sugar addition.
Related Terms: externalities, negative externalities, positive externalities, environmental impact, economic impact.
