In Economics, what is Positive Externality?

Malcolm Tatum

A positive externality is a type of benefit that generates some sort of additional benefit to parties that were not directly involved in the original transaction. With this type of event, the buyer and seller directly involved do receive benefits from the activity, but the nature of the transaction itself has a positive impact on others who have some type of connection with the buyer or seller. This phenomenon can occur in a wide range of setting, with both commercial and personal events triggering some type of positive externality.

An externality is defined as a cost or a benefit stemming from a transaction that affects various third parties who are not part of the transaction.
An externality is defined as a cost or a benefit stemming from a transaction that affects various third parties who are not part of the transaction.

One common example of positive externality in a personal setting would involve a homeowner choosing to make improvements to his or her property. By enhancing the amenities associated with the buildings on the property, such as making landscaping improvements that help to make the area more attractive and inviting, benefits occur on several levels. The property owner has the benefit of a more attractive property that is likely to be considered worth more on the housing market. At the same time, the landscaper benefits from the payment for doing the job. Above and beyond these two parties, owners of the surrounding property benefit, since the landscaping improvements also have a positive effect on the value of their properties, even though they contributed nothing to the task.

Within a business setting, a positive externality may occur when a business chooses to make improvements to a plant operation that help to limit the amount of waste and pollution generated as part of the business operation. For example, if smoke filtration systems are installed in the smokestacks at a paper mill, the company owner probably benefits from being able to receive governmental tax breaks for the activity. The company that manufactured the filtration systems also benefit from the sale to the paper mill. Along with these direct benefits, people living in the general vicinity of the paper mill also benefit, since the fumes and gases that are emitted from the plant are greatly reduced, allowing them to enjoy cleaner air and fewer health hazards, even though they did nothing to assist in the purchase and installation of the filters.

At times, the positive externality that is generated by some type of transaction has far-reaching effects, providing benefits to future generations as well as those living today. As in the case of the filtration systems, the cleaner environment that is created by the installation means that people living in the area in later decades will still be enjoying the benefits of the transaction, even though they were not in the area at the time the systems were installed, or possibly note even born yet. In this sense, the reality of positive externality can be seen as one way that legacies for later generations are created and sustained from one era to another.

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