Externality is a consequence of an industrial or commercial activity that other parties or groups without this being reflected in market prices, For example the pollination of surrounding crops by bees kept for honey.
Externalities arise from Allocation of funds which means that living your life on the cost of others. And in finance it means that earning extra profitability at the cost of others. Externalities are produce by the Allocation of funds.
Types of Externality
There are two types of externality;
- Negative Externality
- Positive Externality
1. Negative Externality
The waste produce by the industries the pollution produced in the environment by the factories, industries who are taking advantage from the government and not paying for it.
Read more about Negative Externality
2. Positive Externality
Benefits for the society at the cost of others.
These externalities lead to market failures. The market failure refers to failure of financial market to allocate fund efficiently. Examples of the market failure include the following:
- When the allocation of funds produces negative externalities of production and consumption
- When the allocation of funds produces positive externalities of production and consumption. Positive externality also produces market failure for example government making highways metro’s but the public don’t need it so it is also effecting people because as people need dams and they produces metro’s etc. It is positive externality but it is producing market inefficiency.
- Lack of public goods also results in market failure. Public goods like air force, army and hospital etc.
- Asymmetry of information leads to market failure.
- Abuse of monopoly power, it leads to market failure.
- Supply side economies
- Stock exchange which is not the representative of the market development.
December 08, 2018