What Is a Positive Externality Example? (With Definitions)
Updated September 30, 2022
Business owners and economists often study the market to understand consumer buying habits. They aim to learn and determine the impact of their products and processes on consumers, communities, and third parties, either directly or indirectly. Learning about positive externalities may help you better understand economic transactions and how these affect society. In this article, we define externalities, discuss a positive externality example, and explore how the government may increase positive externality.
What is a positive externality example?
A good positive externality example is walking or riding a bicycle to work. This activity helps reduce pollution and road congestion, which can benefit residents and individuals working in the area. These people are the third party experiencing the benefits from the results of the walker or biker's action, because instead of driving or taking public transport, they are contributing to a more eco-friendly and sustainable environment.
What are externalities?
Externalities are the cost or benefit impact that a third party sustains as a result of another party's consumption or production of a good or service. The third party that's not directly related to the consumption or purchase experiences costs or benefits that may either be positive or negative. These benefits may affect an individual or collective society.
Technical externalities impact the consumption and production opportunities of unrelated third parties without the inclusion of the price of consumption. This results in a gap between the gain or loss of private individuals and society's collective gain or loss. The government often resolves this challenge through the imposition of taxes, incentives, and regulations.
What is a positive externality?
A positive externality happens when there's gain at both the private and social levels as a result of an economic transaction. In this case, the social level benefits more than the individual or private level. People's consumption of goods typically causes positive externalities to society. This is the reason governments often encourage this activity. There are two common types of positive externality:
Positive externalities of production
These refer to the production of goods or services that benefit an individual, society, or another business. In this case, the producing entity receives no compensation for the additional benefit it provides. The third party also benefits from the production of the goods or services at no charge.
Positive externalities of consumption
These occur when the consumption of goods or services causes a positive effect or spillover to an unrelated third party or an entity lying outside the transaction. In free markets and without government intervention, individuals commonly under-consume these goods and services because the benefits aren't what drives their purchase. This may lead to affects on the economy because of underproduction resulting from underconsumption.
Another perfect example of a positive externality includes investing in education. Educating the population properly can lead to a better and more intelligent workforce that benefits employers. In this case, companies require less investment in training and education. The individual who received an education also benefits from it personally by enjoying more opportunities to advance their career and achieve their personal goals. They may also educate other people or encourage others to pursue education, both of which can benefit future generations and society as a whole.
Examples of positive externality
Different economic transactions may result in positive externalities. These positive externalities happen as a consequence of production or consumption by individuals or business owners. Here are some examples of positive externalities that may help you better visualize and understand the concept:
Building new local businesses, amenities, and commercial structures can increase the value of existing local properties. It may also create jobs and provide income to residents, which may stimulate and improve the local economy. This benefits the local residents even if they don't use the new buildings or patronize the new businesses.
Constructing train or bus stations may provide shelter to homeless people during the winter. Developing public goods, such as bridges, roads, and airports, can generate positive externality for the residents around the area. The businesses with involvement in these scenarios receive no extra compensation for providing more benefits to society.
The advancements and innovations in technology create benefits for the whole society. A new technology or process results in productivity gains that may create positive spillover effects. When a company develops new technology, such as a new database program or software, they may boost the productivity of other similar businesses.
Pharmaceutical companies conduct research to develop new drugs. Creating a novel drug can improve a patient's quality of life and even save lives, which produces a private benefit to each individual who uses the medication. This also directly benefits the company through earnings on the new product's sales. In this instance, other people can benefit from the transaction indirectly, such as the family and friends of the people who use the new medication.
Investing in education provides a private benefit to the individual receiving it and can potentially benefit a third party. It may serve society because there's a connection between an educated population and lower unemployment rates. So education may improve the local economy.
Educated employees keep businesses operating through their expertise, and this can contribute to an organization's long-term success. Third-party entities relying on the services and support from these businesses, particularly nonprofits, may continue to benefit because of the company's positive performance. Education can also create a population that can communicate effectively. Every well-researched article, book, or post that results from the work of an educated group can benefit any third party who reads it.
Companies often include training plans in their objectives to help develop their employees' skill sets. This can benefit both the company and the employee. The organization may experience productivity gains and the individual boosts their credentials with the additional knowledge they received during training. When the employee transfers to another company, the new employer benefits from the training and skills the individual gained from their previous job. Other people may also benefit from the employee's training, particularly when the skill is life-saving, such as cardiopulmonary resuscitation or CPR, first aid, or mental health training.
People often purchase goods and services online. This transaction between a buyer and seller can help create and support the employment of manufacturers, delivery riders, and couriers. This may result in a positive benefit to society because of the taxes they pay and the money they spend, which can stimulate and improve the local economy.
Vaccines can protect an individual from contracting contagious diseases and infections and provide income to manufacturers or pharmaceutical companies. Vaccination may create a positive externality for other people in the community because it may prevent the spread of diseases that can affect their quality of life. It can also provide protection to other residents in the area, especially the vulnerable and immunocompromised third parties.
Local and personal investments
Investing in real estate properties, such as building new structures or renovating existing buildings, may benefit the community by increasing the market value of the local properties. The architecture makes the building or property more attractive and desirable, which may attract investors and new businesses in the area. This can stimulate the local economy and provide benefits to the local residents that include their quality of life.
An insurance policy can create a positive externality for a third party. In an accident, without insurance and if the party that caused the accident is incapable of covering the expenses, it may be necessary for the third party to cover the medical and other relevant costs themselves. With the security of insurance, the third party with involvement in the accident may file a claim to the insurance company to finance repairs or hospital bills.
Increasing positive externality
Some externalities may lead to underconsumption and market failure. To prevent this, the government can impose measures and economic policies to encourage and promote positive externalities through the supply and demand principle. Here are some approaches that the government may use to encourage positive externalities:
Implementing rules and regulations
The government responds to externalities through command-and-control policies. They may create regulations to control behaviour. This may include standards, process requirements, bans, and targets. They may also implement market-based policies, such as tax deductions, to incentivize private companies. These may result in a change in the companies' behaviour and business practices.
Increasing supply and demand
The government helps encourage positive externality by providing grants and subsidies to producers to increase the supply of and demand for goods. The provision of subsidies to producers that generate positive external benefits reduces the cost of production and increases supply. Subsidies on goods and services reduce the prices that consumers pay and promote consumption.
Related: What Is Macroeconomics?
Targeted advertisements and public service announcements inform the public about the benefits of consuming a particular product or service. They help people understand how they can directly contribute to society through the consumption of these goods and services. This can encourage them to increase their purchases.
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