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Externalities (excluded from transaction costs)

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'Externalities' in the economy describe spillovers to third parties that occur without their permission (or sometimes even without their knowledge). This is often an additional cost and thus a negative thing, but it does not necessarily have to be. These additional costs or benefits are not captured in the cost of producing a good or the price of buying it – e.g., pollution from industry or agriculture that results in contaminated waters or air, causes illness and lost revenues (e.g., from fishing or even worker productivity), or carbon captured by trees planted by an individual for their aesthetic beauty. The costs or benefits usually arise in another system such as high healthcare or cleanup costs. Economists consider negative externalities market failures that distort the market and the economic landscape.

(David Susuki's view on the concept of externalizing costs in economics)

Negative externalities pop up in much of the US economy, but are often not considered a clear and present enough danger to merit action (see the precautionary principle). Culprits are sometimes difficult to pinpont as well. This obscurity makes it difficult guard against them. Many critiques of modern economics argue that meaningful change to prevent negative externalities would necessitate fundamental change to large and entrenched social structures.

Negative externalities may be accounted for through the use of mechanisms which increase prices or costs, reduce production, demand, or usage of a product and therefore its impact. The additional funds then go to offsetting the externalities that cannot be prevented. One example of this is tax on tobacco products in the US to make it annoyingly expensive and help fund the healthcare costs associated with smokers. Likewise, this concept is the environmental and economic basis for the idea of the proposed carbon tax or fossil fuel divestment. Divestment pulls investment funds out of fossil fuel companies, hopefully to impact their bottom line and force a change to some aspect of their business model. Some would prefer these companies fail altogether. In any case, divestment is a way of 'putting one's money where one's mouth is' in regards to supporting a sustainable future.

Alternatively, positive externalities can be encouraged through use of subsidies and tax breaks. A simple graphical illustration of of these points is available here at the Khan Academy.

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