The production externality is a concept which deals with the social benefits of goods and services. Production externalities are often ignored in economic analysis because they cannot be directly measured or calculated. A negative production externality, for example, would include pollution from a factory that lowers the value of neighboring properties and imposes costs on those not producing the good.
Positive production externalities usually occur when innovations lead to increased output and lower prices for consumers. For instance, if an entrepreneur invents a cheaper way to produce soap, this may reduce the price of soap so people can purchase it more easily than before while also increasing total output available in society as well as promoting innovation within the industry. The benefits of production externalities do not stop there.
Consumers also benefit from the increased variety of products, because now they can purchase soap at a lower price and still have options for different types of soaps to meet their needs. Even if consumers only purchase the cheaper soap and the more expensive soap remains unchanged, society as a whole benefits because the people who would have bought the expensive soap can now purchase two or more cheaper soaps instead. The increased variety and lower prices of consumer products also stimulates demand for many other related products which typically increases employment opportunities in such industries.
What is an example of positive externalities?
For example, if a new washing machine is invented using less electricity than before, it will bring about savings for consumers, increased output and variety in the market, as well as stimulate demand for electricity which increases employment opportunities. Furthermore, all of these benefits usually result in lower prices to the consumer as we have witnessed in the products of clean technology.
A similar situation is seen when new technology reduces the cost of packaging per unit of product produced. A food packing company may decide to reduce costs by buying a robot to pack products instead of having humans do it. This reduces the cost per unit of product packed and saves the company money while also benefiting consumers by increasing output and variety of available products, leading to lower prices. In addition, this increases employment opportunities for people who build robots but would have lost their jobs if companies continued using manual labor to package products.
According to this positive production externality, the best way society can benefit is through encouraging entrepreneurship and reducing barriers to entry in industries that are already functioning well. This leads to increased output, variety, lower prices and more employment opportunities for the economy as a whole.
Why is positive production externality a market failure?
Positive production externalities are a market failure because it’s not profitable for any individual company to produce the goods and services, or corporations which create benefits for society as a whole. Instead, these goods and services only exist because they’re beneficial to society and someone has taken the time and resources to create them.
This can be contrasted with negative production externality, which is often the consequence of market failures such as pollution, congestion on a road or any other side-effect that imposes costs on those not producing the good (i.e., people who purchase the good). In such cases, government intervention may be necessary to regulate or subsidize production in order to make sure that production doesn’t outweigh the social benefits of negative production externalities.
For instance, if a factory produces chemicals that are polluting the environment, government regulation for its production might be necessary. On the other hand, if a new type of product creates benefits such as increased variety and lower prices for consumers, this is not considered a negative externality and instead represents an example of a positive production externality.
What is a positive consumer externality?
A positive externality is a beneficial outcome that yields as a side effect or by-product of an economic transaction or activity. In other words, one person’s costs are another’s benefits.
Consumer externalities have been studied in economics for decades, but the most famous example is probably the market for prescription drugs. There are a number of consumer externalities in the market for pharmaceuticals. One such externality is that pharmaceutical companies can’t produce a drug without knowing that it will be bought. Even if they spend millions of dollars on R&D and come up with an amazing new medicine, it won’t be produced unless there is demand from consumers (or health care providers). This introduces uncertainty into the pharmaceutical producer’s decision making and can result in a lot of wasted resources, which we see today.
Another example is where consumers use the same good or service provided by different companies (i.e., differentiated products) instead of producing their own for all or part of it. For example, if there were no coffee shops, millions of people would still produce their own coffee at home. This is another positive externality because the coffee shop owner doesn’t have to pay for your labor of producing your cup of coffee, but you still benefit from his or her product.
Positive consumer externalities are common in industries that are already established and functioning well. The best way society can benefit is through encouraging entrepreneurship and reducing barriers to entry in industries that are already functioning well. This leads to increased output, variety, lower prices and more employment opportunities for the economy as a whole.
What is a positive production externality?
Positive production externalities occur when an individual’s costs benefit someone else; these benefits may be either tangible or intangible. For example, a driver doesn’t pay the full cost of road construction and maintenance, since these benefits are enjoyed by all those who use the road.
However, what’s most relevant from an environmental perspective is that positive production externalities also offer tangible benefits for people living in society as a whole. In other words, they benefit everyone except those who are responsible for creating them.
Here are some examples of positive production externalities in action:
- The automobile industry has long been an example of a sector that creates many positive production externalities. As the number of automobiles on the road increases, so does the demand for oil and gasoline. However, this increasing revenue helps to offset the increasing costs associated with building roads, parking lots and traffic signs. Even though the road construction industry doesn’t receive additional revenue when the automobile industry makes more money, they are compensated in part by having to deal with fewer cars.
- Innovation often leads to lower prices for consumers. For instance, Microsoft created Word to help academic institutions manage research papers for their students. Since it was an innovative technology, they were able to produce it at a cheap price. This means that Microsoft has not only created more employment opportunities, but they have also lowered the prices for consumers everywhere who would like to use their product.
- When Apple first launched the iPod, it helped create an entirely new market for MP3 players. This was great for consumers because it meant more variety, which lowered the prices of MP3 players. However, this innovation also helped other companies make better products and lower their prices as well; this is an example of a positive production externality at work within an already-established market.
What are the 4 types of externalities?
Production externalities can be classified into four types: negative, positive, total and marginal.
- A negative production externality is a cost that one party imposes on another party (usually unintended and and off-setting). It can come in the form of pollution or congestion on a road, for example.
- A positive production externality is when the benefits from an individual’s cost are enjoyed by others unambiguously. This person doesn’t pay the full cost of road construction and maintenance because all those who use the road do so without paying anything extra.
- Total production externalities are similar to positive but they can bring costs to society as well as benefits. When there is a new innovation that leads to increased output and lower prices for consumers, it can bring costs to the producers of the product. An example is a pharmaceutical company developing a drug that promotes weight loss and reduces cholesterol. Since this is a new innovation, the life-cycle of the product will likely be shorter than other similar products on the market, thus creating additional revenue opportunities for new companies to enter this industry.
- Marginal production externalities are costs and benefits on the margin. This type of externality occurs when a new product enters an already-established market, such as Apple’s iPod, where prices for MP3 players were lowered as more companies began to produce them.
Consumption externality vs production externality
A consumption externality is when there’s a cost to one person and a benefit to another and the same with a production externality. If someone buys a car, there will be benefits for the car industry and costs for the roads. If someone makes a car there are benefits for the car industry and costs for the roads. The main difference is who is responsible for paying and who gets the benefits. With a consumption externality, the person with the cost is usually responsible for paying while with a production externality, it’s usually someone else.
In conclusion on positive & negative externalities
In conclusion, production is an essential part of life. Whether it’s for business, everyday use or something entirely different, without production there would be no creation or innovation. Even though many products come at a price, they also bring benefits to society. It may not always be directly associated with the producer but it still helps immensely in someway. Every product brings with it a certain amount of positive and negative production externalities. Sometimes the benefits outweigh the costs, which is why people continue to produce quality products at affordable rates. From Microsoft Word to iPhone, all products create something beneficial for society whether that’s recorded history or just a fun way to stay connected with friends and family. If there were no production externalities, there would be no reason to innovate or create new products and that just wouldn’t make sense. Innovation is key in keeping the economy afloat and ensuring that life runs smoothly for everyone.
Caveats, disclaimers and a negative externality
We have covered many topics in this article and want to be clear that any reference to, or mention of
work in progress or carbon emissions in the context of this article is purely for informational purposes and not to be misconstrued with investment advice or personal opinion. Thank you for reading, we hope that you found this article useful in your quest to understand ESG.