(i) Positive Externalities:
A positive externality is something that benefits society, but in such a way that the producer cannot fully profit from the gains made. A few examples of positive externalities are environmental clean-up and research. A cleaner environment certainly benefits society, but does not increase profits for the company responsible for it. Likewise, research and new
technological developments create gains on which the company responsible for them cannot
fully capitalize. Street lighting, etc.
(ii) Negative Externalities:
A negative externality is something that costs the producer nothing, but is costly to society in general. Unfortunately these externalities are much more common. Let's take an example of
pollution. This is a very common negative externality. A company that pollutes loses no
money in doing so, but society must pay heavily to take care of the problem pollution caused.
The problem this creates is that companies do not fully measure the economic costs of their
actions. They do not have to subtract these costs from their revenues; hence profits
inaccurately portray the company's actions as positive. This can lead to inefficiency in the
allocation of resources.
(iii) Fiscal Externalities:
This is whereby the behavior of people affects the cost of some subsidy or alters the revenues from some tax as externalities. Fiscal externalities do not necessarily imply any inefficiency, and when there is inefficiency, it is the result of the pre-existing policy. An example is smoking; this imposes costs on taxpayers due to the existence of subsidized medical care. In this case the medical care subsidy creates the fiscal externality.
However, when there is inefficiency, the nature and magnitude of the fiscal externality is not a reliable guide to the appropriate corrective policy. Like in the above example, it will usually be best to modify the pre-existing policy (the medical care subsidy) rather than tax smoking.
Faimus answered the question on February 25, 2019 at 19:52
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