Question

Which of the following statements regarding ‘Externalities’ are correct?
1. Externalities can be both positive as well as negative.
2. Externalities do not have any market in which they can be bought and sold.
3. Education cannot be an externality.
Select the correct option using the options given below:
(a) 2 and 3 only
(b) 1 and 2 only
(c) 1 and 3 only
(d) 1, 2, and 3

Answer 1

Answer:

option c is correct

Explanation:

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Answer 2

Option (b) :- 1 and 2 only

More Information

■ Externalities :-

• Externalities refer to the benefits (or harms) a firm or an individual causes to another for which they are not paid (or penalized).

• Externalities do not have any market in which they can be bought and sold.

• For example, let us suppose there is an oil refinery that refines crude petroleum and sells it in the market. The output of the refunery is the amount of oil it refines. We can estimate the value-added of the refinery by deducting the value of intermediate goods used by the refinery (crude oil in this case) from the value of its output. The value-added of the refinery will be counted as part of the GDP of the economy.

• But in carrying out the production the refinery may also be polluting the nearby river. This may cause harm to the people who use the water of the river. Hence their well being will fall. Pollution may also kill fish or other organisms of the river on which fish survive. As a result, the fishermen of the river may be losing their livelihood.

• Such harmful effects that the refinery is inflicting on others, for which it will not bear any cost, are called externalities. In this case, the GDP is not taking into account such negative externalities.

• Therefore, if we take GDP as a measure of the welfare of the economy we shall be overestimating the actual welfare. This was an example of the negative externality.

• There can be cases of positive externalities as well. This occurs when the consumption or production of a good causes a benefit to a third party.

• For example: When someone consumes education, she gets a private benefit. But there are also benefits to the rest of society.

• In such cases, GDP will underestimate the actual welfare of the economy.

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