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What Are External Economies?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 05 September 2016
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External economies are benefits that are created when an activity is conducted by a company or other type of entity, with those benefits enjoyed by others who are not connected with that entity. The entity that is actually managing the activity does not receive the external economies, although the creation of these benefits for outsiders usually has no negative impact on that entity. The nature of the benefits may include providing inspiration for some new idea, or even something as simple as providing a visual image that the viewer finds appealing.

One way to understand how external economies occur is to consider the display window at a local furniture store. The purpose of the window is to present the goods on display in the most appealing manner, hopefully prompting potential customers to stop, see the display, and come into the store and make a purchase. In this way, the store generates direct or internal benefits for its efforts. At the same time, if someone passing by notices the display, is inspired by the furniture arrangement, and goes home to rearrange his or her furniture in a new way, that individual has received an external economy that is never realized by the furniture store.

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External economies are the opposite of what is known as external diseconomies. With the former, some sort of benefit is generated to outside parties, without really triggering any benefits for the business engaging in an activity. The latter involves the creation of some sort of loss for an outside party, with that diseconomy not really impacting the originator of that activity.

One aspect of external economies is that benefits of this type will not have any impact on the prices of goods and services in the marketplace. The furniture store that created the window display will not adjust its pricing based on the fact that a passerby received a benefit in the form of inspiration to rearrange his or her furniture. From this perspective, the creation of external economies has no relevance to the market price of goods or the market price of services provided by a given company. This is true even if a number of people notice the display and develop several different ideas of how to rearrange the furniture in their homes. As long as the pricing for the goods is competitive with similar goods offered for sale by other businesses, supply and demand will exert influence on market prices, with no real consideration of external economies that result from the attempt to sell those goods.

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SteamLouis
Post 3

A good example of an external economy is the farmer whose crops are pollinated thanks to the bees of the beekeeper next door. The beekeeper doesn't experience any benefits, he's probably not even aware that his bees are helping the next door farmer.

bluedolphin
Post 2

@SarahGen-- External economies of scale are external factors that help a business lower the cost of its goods and services. In external economies, there are no benefits for the business, in external economies of scale, there are. So the former do not affect the market whereas the latter do, as the article said.

The opposite of external economies of scale are diseconomies of scale where external factors increase the cost of producing goods and services for a firm.

External economies are basically the third parties that are affected by what businesses do. This effect may be negative or positive and it's usually a social phenomenon. Regardless of what the effect is, the third party or the external economy has no say in the business' actions and there is no official transaction between them.

SarahGen
Post 1

What is the difference between external economies and external economies of scale?

And are external economies usually ideas or can a material good be an external economy?

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