External Economies

Definition

External economies, also known as positive externalities, are the benefits that occur to others outside of an economic transaction. These benefits are provided by an entity but enjoyed by individuals or groups who do not pay for them. As a result, the entity producing these benefits has no economic incentive to continue doing so unless other compensatory mechanisms are in place.

Examples

Public Parks and Recreation Areas: Public parks provide recreational space not only for those who actively use them but also for nearby property owners who benefit from increased property values and an aesthetically pleasing environment.
Education: A well-educated population benefits society at large through greater innovation, higher productivity, and reduced crime rates, even though the costs are borne by the students and/or the state.
Healthcare Vaccinations: Immunizations reduce disease spread, thereby protecting individuals who did not receive the vaccination.
Street Lighting: Adequate street lighting contributes to public safety and security, benefiting the community beyond those directly maintaining the lights.

Frequently Asked Questions (FAQ)

1. What are external economies?

External economies occur when an entity’s actions produce benefits for others without being compensated.

2. How are they different from internal economies?

Internal economies benefit the entity conducting the activities, while external economies benefit third parties.

3. Why do producers have no incentive to create external economies?

Since the producers are not compensated for these external benefits, they do not have a direct financial incentive to continue producing them unless other mechanisms (like government subsidies) are established.

4. Can external economies lead to market failures?

Yes, because the market may under-produce beneficial goods and services that create external economies, necessitating government or community intervention.

5. How can society encourage the production of external economies?

Society can encourage them through subsidies, tax incentives, regulations, or public funding of beneficial activities.

Negative Externalities: Costs imposed on third parties, such as pollution from a factory affecting nearby residents.
Public Goods: Non-excludable and non-rivalrous goods that benefit all, like national defense.
Market Failure: Situations where free markets fail to allocate resources efficiently, often due to externalities.
Subsidies: Financial support given by the government to encourage activities seen as beneficial to society.
Social Cost: The total cost to society, including both private and external costs.

Online Resources

Suggested Books for Further Studies

“Economics of the Public Sector” by Joseph E. Stiglitz - A comprehensive guide on public sector economics, including externalities.
“Microeconomics” by Robert Pindyck and Daniel Rubinfeld - Offers insights into microeconomic principles, including externalities.
“Public Finance and Public Policy” by Jonathan Gruber - Covers various aspects of public economics, including the impact of externalities.
“The Economics of Welfare” by A. C. Pigou - A foundational text on welfare economics and externalities.

Fundamentals of External Economies: Economics Basics Quiz

### What are external economies? - [x] Benefits enjoying by third parties not involving in the economic transaction. - [ ] Costs imposed on third parties by the producer. - [ ] Direct financial incentives received by the producer. - [ ] Government taxes on production. > **Explanation:** External economies refer to benefits received by third parties who are not directly involved in the economic transaction. The producer doesn't get compensated for these benefits. ### Which of the following is an example of an external economy? - [ ] Pollution created by a factory. - [ ] Private shopping malls. - [x] Public street lighting. - [ ] Factory-owned amenities for employees. > **Explanation:** Public street lighting is an example of an external economy because it benefits the community by improving safety and utility, but the community members do not pay directly for the service. ### Why might a producer not have an incentive to create external economies? - [ ] They want to harm other parties. - [x] They are not compensated for these benefits. - [ ] The government restricts them. - [ ] The costs are too high. > **Explanation:** Producers do not have an economic incentive to create external economies because they are not financially compensated for the benefits provided to third parties. ### How can the government encourage the creation of external economies? - [ ] Prohibiting such benefits - [x] Providing subsidies or tax incentives - [ ] Increasing product prices - [ ] Reducing financial regulations > **Explanation:** Governments can encourage the creation of external economies by offering subsidies, tax incentives, or other supportive measures to the producers. ### Which term is closely related to external economies and includes both benefits and costs to third parties? - [ ] Public Goods - [x] Externalities - [ ] Internal Economies - [ ] Market Prices > **Explanation:** Externalities encompass both positive (external economies) and negative impacts (external costs) on third parties, making it closely related to external economies. ### Boosting education in society is considered as producing which type of externality? - [ ] Negative externality - [x] Positive externality - [ ] Neutral externality - [ ] Marginal externality > **Explanation:** Education produces positive externality because its benefits, such as higher productivity and lower crime rates, positively impact society at large. ### What impact can the under-production of beneficial goods and services due to external economies cause? - [x] Market Failure - [ ] Market Equilibrium - [ ] Increased competition - [ ] Decreased productivity > **Explanation:** The under-production of beneficial goods and services due to external economies can cause market failure, as the beneficial activities are not being sufficiently produced and enjoyed by society. ### Street lighting benefiting the entire community is an example of which type of good? - [x] Public Good - [ ] Private Good - [ ] Club Good - [ ] Common-Pool Resource > **Explanation:** Street lighting is a public good because it's non-excludable and non-rivalrous, benefiting everyone in the community without individual charges. ### What often necessitates government intervention when external economies exist? - [ ] Market Efficiency - [x] Market Failure - [ ] Surplus Creation - [ ] Decreased Demand > **Explanation:** External economies often necessitate government intervention due to market failure, where free markets do not efficiently allocate resources to produce goods and services that have beneficial externalities. ### To correct for positive externalities, the government may offer? - [x] Subsidies - [ ] Tariffs - [ ] Penalties - [ ] Quotas > **Explanation:** To correct for positive externalities, the government may offer subsidies to encourage the production of goods and services that provide external benefits.

Thank you for exploring the intricacies of external economies and testing your understanding through our comprehensive quiz. Keep enhancing your economic knowledge!