Chapter Ten: Externalities (Level of Difficulty 2)

The impact that one person's decision has upon a bystander( or a third party) is considered to be an externality. Externalities can be either positive or negative. Positive externalities create a smaller quantity than socially desirable, where government can apply a subsidy. Negative externalities on the other hand have a larger quantity than socially desirable. Government can intervene in such situations to internalize the externality and alter the incentives that buyers have, since people will take into account the external effects of their actions. Taxes may be applied to a negative externality to lower the quantity provided, while subsidies are added to positive externalities to add upon growth. Public Policies are another type of solution that can be used to help externalities, whether it is by regulating  behavior or internalizing an externality using corrective taxes. Permits are another solution, where they can provide a minimum and a maximum amount of a good. In other cases externalities may be reasoned on by private agreements. Private agreements occur when the Coase Theorem comes into play. Thus, businesses or other companies may settle the problem in their own hands by agreeing with each other. However most of the time, agreements that are made privately do not come to happen due to such disagreements. The government helps the invisible hand solve problems that could not be done alone. Solutions are placed to help the market function reasonably, and help things market cannot fix on its own because sometimes what is most efficient, may not be "efficient" after all.