[MUSIC] In the next few segments, we will explore the issue of externalities. An externality is a situation where someone is impacted by a transaction that is neither the consumer nor the producer. So it's a third party that is impacted through a transaction of a good. A negative externality imposes a cost on a third party, and a positive eternality creates a benefit on a third party. Let's give a few examples. An example of a negative externality might be smoking. When someone smokes they take into account the benefit that they get from smoking, the nice feeling. They take into account the costs of smoking, both the cost to their health and the cost of the cigarettes themselves. The firms selling the cigarettes take into account the cost of producing a cigarette, and of course they take into account the revenues that they get from selling the cigarettes. But when someone smokes they impact the people around them. This is secondhand smoke. And secondhand smoke creates a nasty environment for the people surrounding the smoker. It might be just a matter of how they feel. They just feels yucky, it smells bad, or it might be a health cost. Whatever it is, this is a third party. They're not part of the transaction. They didn't decide to smoke. They didn't decide to sell cigarettes. And nonetheless, they are impacted by cigarettes. That is why this is a negative externality. Another example of a negative externality might be a CO2 emissions. When I drive my car and I burn energy, I'm creating CO2 that goes up in the sky and contributes to global warming. When I drive my car, I take into account the benefit of driving the car, I take into account the price of gasoline. The firm selling the gasoline takes into account the cost of creating the gasoline, pumping it out of the soil, and it also takes into account the revenues that they get from selling the gasoline. But neither me not the seller of the gasoline is taking into account the externality, the fact that by driving my car, I'm contributing to global warming that will impact everyone else in the world. That's is why it is an a externality because we're not taking it to account. Lets give a couple of examples of positive externalities. Vaccine creates a positive externality. If you go ahead and get your flu shot, you take into account the benefit to yourself, and the cost of a flue shot, the pain that you might experience getting the shot, the price you have to pay in order to get a flu shot. And the firm making the vaccine, again, they'll take into account the cost of creating the vaccine and the revenues that they get from giving you the vaccine. But if you get a flu shot, people around you are less likely to be sick. So you will be creating a positive externality. Again, a benefit to society that is not taken into account by either the consumer or the producer. One last example. Education is a nice example, of creation of positive externalities. When, I send my kids off to school, I take into account the benefit to them, and any costs that I might incur, in terms of books, in terms of time, in terms of the hassle of taking them to school. And of course, the provider of education takes into account any salaries that they get from providing education. But there a big external benefits of education as well. If someone is educated they're more likely to be a contributing member to society. That means they're more likely to get good jobs and, therefore, they're more likely to pay taxes. And those future taxes are an external benefit for society as a whole. People who are educated also make better citizens, and that better citizenship impacts us all. So again, this is a positive externality. So to conclude in this segment, we want to look at why negative externalities and positive externalities create a market failure. Why markets where externalities exist do not provide the optimal output. And then we want to think about what we can do about this.
