External cost – definition
An external cost is the cost incurred by an individual, firm or community as a result of an economic transaction which they are not directly involved in. External costs, also called ‘spillovers’ and ‘third party costs’ can arise from both production and consumption.
Many, if not most transactions create external costs – examples include:
- Purchasing consumer goods commonly creates waste in terms of packaging, as well as other environmental costs including carbon emissions resulting from travelling to stores and outlets.
- Environmental costs can also arise from the production process, including direct costs from emissions and costs from transportation and distribution.
- Excessive fishing can deplete fish stocks and lead to unemployment in the fishing industry in the future.
Where the goods are ‘demerit goods‘, such as cigarette and alcohol consumption, governments may impose taxes to discourage consumption and reduce external costs. Information failure may result in a lack of awareness of external costs, and hence a sub-optimal level of consumption.
Diagram to show an external costs from production:
Stagflation is a combination of high inflation, high unemployment, and stagnant economic growth. Because inflation isn't supposed to occur in a weak economy, stagflation is an unnatural situation. Slow growth prevents inflation in a normal ...
The laissez-faire economic theory centers on the restriction of government intervention in the economy. According to laissez-faire economics, the economy is at its strongest when the government protects individuals' rights but otherwise doesn't intervene. The ...
What Is Adverse Selection? Adverse selection is a term that describes the presence of unequal information between buyers and sellers, distorting the market and creating conditions that can lead to an economic collapse. It develops ...
Explaining The K-Shaped Economic Recovery from Covid-19 A K-shaped recovery exists post-recession where various segments of the economy recover at their own rates or levels, as opposed to a uniform recovery where each industry takes the same ...
Does Public Choice Theory Affect Economic Output? Both on paper and in real life, there is a solid relationship between economics, public choice, and politics. The economy is one of the major political arenas after all. ...
Largest Retail Bankruptcies Caused By 2020 Pandemic As we know at this point, the COVID-19 pandemic has thrown major companies in the US and the world over into complete havoc. Many have filed for bankruptcy, with an ...