An externality is a consequence of an economic activity that affects unrelated third parties either in positively or negatively. In economics, the Coase theorem explains the economic efficiency of an economic outcome or economic allocation in the presence of externalities. This theorem states that if trade is possible in externalities and there are enough low transaction costs, than bargaining between will make an efficient outcome. This paper 1960 earned Nobel Prize in economics in the 1991. In this paper Coase argued that transaction costs are very low in the real world to allow for bargaining efficiently and as a result this theory is almost inappropriate to the economic discipline. Positive externalities help in the society by creating welfare gain, and negative externalities affect society by making welfare loss. There are some possible solutions of negative externalities, among them the most important are, pigovian taxes and subsidies, regulation, government provision etc (ROSEN, 2012)
Definition of Externalities:
An externality, in economics, is the benefit or cost that affects people or a group of people who did not choose to incur that benefit or cost (uchanan, James, 1962).
According to Investopedia, An externality is a consequence of an economic activity that affects unrelated third parties either in positively or negatively. That means externalities are two types (Coase, 1960).
Types of externalities: There are two types of externalities.
- Positive externalities. In this case, third party becomes better off.
- Negative externalities. In this case, third party becomes worse off.
Yale University, Economics.