Externality – Indian Economy Notes for UPSC
An externality is a situation where the actions of an individual, firm, or government affect third parties who are not directly involved in the activity. These effects can be either positive or negative and are not reflected in the market price of goods or services.
Externalities are a critical concept in economics, particularly in the context of market failure, where the market does not allocate resources efficiently.
Types of Externalities
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Positive Externalities
These occur when the actions of individuals or firms create benefits for others without those benefiting parties having to pay for them.
Examples:
- A farmer planting trees on their land absorbs carbon dioxide, improving air quality for the surrounding community.
- The farmer's action benefits others (third parties) who did not contribute to the tree-planting effort.
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Negative Externalities
These arise when the actions of individuals or firms impose costs on others.
Examples:
- A factory emitting pollution into a nearby river affects the local community's health and reduces access to clean water.
- Here, the factory's operations (action) harm the residents (third parties) who are not directly involved in the factory's activities.
Key Characteristics of Externalities
- Unintended Effects: Externalities are unintended side effects of economic activities.
- Third-Party Impact: They affect individuals or groups who are not directly involved in the transaction.
- Market Failure: Markets fail to account for externalities, leading to overproduction or underproduction of goods/services.
Policy Measures to Address Externalities
Governments and policymakers intervene to correct externalities and ensure resource efficiency. Common measures include:
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Taxes and Subsidies:
- Pigouvian Tax: A tax imposed on activities that generate negative externalities (e.g., carbon tax).
- Subsidies: Encouraging activities with positive externalities (e.g., subsidies for renewable energy).
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Regulation:
- Setting limits on pollution levels or mandating the use of cleaner technologies.
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Tradable Permits:
- Cap-and-trade systems allow firms to buy/sell pollution permits, incentivizing reduced emissions.
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Public Awareness Campaigns:
- Promoting awareness about the benefits of actions like recycling and energy conservation.
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Direct Government Provision:
- Providing public goods like education and healthcare to maximize social benefits.
Externalities in the Indian Context
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Positive Externalities in India:
- Ayushman Bharat: Improves public health, reducing disease burden on society.
- Rural Electrification: Enhances productivity and education in rural areas.
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Negative Externalities in India:
- Industrial Pollution: India's rapid industrialization has led to environmental degradation.
- Urban Congestion: Overcrowded cities lead to increased traffic and pollution.
Case Study: Air Pollution in India
- Problem: Major cities like Delhi face severe air quality issues due to vehicle emissions, crop burning, and industrial activities.
- Government Response:
- Introduction of BS-VI fuel standards.
- National Clean Air Programme (NCAP) to reduce particulate pollution.
