What is an externality How can we deal with these externalit

Solution

An externality is the consequence of an economic action taken by an economic entity, which is enjoyed (for positive externality generating benefits) or borne (for negative externality generating costs) by another economic entity.

For example, a road built by a private firm for its use is a positive externality (local residents can also use it without paying), but pollution is a negative externality (social cost).

In general, government tackles positive externality by imposing a subsidy which raises consumption, and imposes a tax on negative externality to reduce consumption.

Externalities result in social welfare loss (deadweight loss) for the society, to rectify which, government intervention is warranted.