Why You Should Understand Economic Externalities

TW: Have been meaning to post this forever. So here goes. Some of you may understand negative externalities well, if so move on. But externalities are crucial to understanding our economic system. There are positive and negative externalities. My example is simple: the neighbor's yard.

The positive externality:
A neighbor who cuts their grass regularly; plants exotic, colorful and attractive fauna; meticulously grooms their lot; are friendly, good-looking, if they have kids they are well-behaved and offer to help carry your groceries if need be; they drive nice cars always well-washed, if they entertain they do it tastefully and perhaps even invite you to a party with interesting and even celebrated folks. In other words, folks one would like to have around.

The negative externality:
A neighbor who poorly maintains their lot; can't be bothered to groom their property or even worse plants hideous weed like things; they frown al ot; drive old Pontiacs; their sons inspired by their parents believe re-habbing old pick-ups including those of their friends is a nice hobby since it makes nice use of extra driveway space; and if invited to one of their parties you decline as you are not a fan of illegal inhaled substances etc.

Both hypotheticals create impacts to the neighborhood yet in neither case do the neighbors pay for the positive benefits or receive compensation for the negative. They are externalities- situations where the market does not directly price in economic impacts. Now non-price actions can sometimes mitigate the externalities which is why things like local ordnances exist but as we all know those inevitably have holes and can be challenging to enforce regardless. Also real estate pricing can directly and otherwise influence the who lives in a particular neighborhood but wealth does not guarantee classiness or good taste.

I bring up externalities because markets are not perfect and externalities are one of the big holes. It follows if externalities are not priced in, an economy will produce too much of those things with negative externalities (i.e. pollution) and too little of those things with positive externalities (i.e. parks). Governments seek to address both through regulation and targeted spending. If governments are involved then we have political implications which I will get into in later posts.