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Externalities (costs excluded from transaction costs)



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Externalities are costs not captured by the market – e.g., pollution from the burning of fossil fuels that results in contaminated fish and air that causes respiratory illnesses and lost revenues (e.g., from fishing). These costs are not reflected in market prices at say the gas pump or the electricity meter, but rather arise in another system such as healthcare. Negative externalities are considered by economists as "market failures" that distort the market and the economic landscape.

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

Externalities arise in much of what we consider to be the economy. As we drive species towards extinction based on the pursuit of profits, we run the risk of destabilizing ecosystems and their overall health, which ultimately defines our overall health as well. These unaccounted for costs often do not have a clear and present danger or culprit, making them difficult to prevent and guard against. Many people argue that it is fundamental changes to large social structures that must predicate change if we are to do anything meaningful to prevent further externalities. Critiques of modern economics often discuss how the economy is destroying the planet through various unaccountable externalities and how this cannot be allowed to continue.


Externalities may be accounted for through the use of pricing mechanisms, such as a tax, that raises the price, which reduces demand and, therefore, the quantity of the goods produced. This is the environmental and economic basis for the idea of the proposed carbon tax or fossil fuel divestment, that seeks to pull investment funds out of fossil fuel companies to force those companies to change some aspect of their business model, or to cause them to fail altogether.

(CC Image (left) by Struthious Bandersnatch (Own work) [CC0], via Wikimedia Commons)


A simple graphical illustration of of the economics of externalities is available here at the Khan Academy.

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by Sorby, Coty E last modified Aug 07, 2014 11:05 AM

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