External Economies, often referred to in economic theory, are benefits that are conferred to third parties who are not directly involved in an economic transaction. These external benefits occur outside of the market transaction between the producer and the consumer, and they provide advantages to others without compensation. The lack of direct economic incentives for the producer may lead to underproduction of these benefits.
Types of External Economies
Technological External Economies
Technological external economies occur when advances or efficiencies in one firm lower the production costs or increase the productivity of other firms. This can happen through knowledge spillovers where innovations benefit multiple industries.
Pecuniary External Economies
Pecuniary external economies emerge when the actions of firms in one industry lead to lower costs or higher revenues for firms in another industry through changes in market prices.
Real-World Examples
Golf Courses
A golf course enhances the aesthetic appeal and airborne ambiance of the surrounding locality, thereby increasing property values for nearby residents, even if they do not frequent the golf course.
Education
An individual’s education can benefit society by creating an informed and skilled workforce, capable of innovation and productivity enhancements, benefitting those who did not invest directly in the education.
Historical Context
The concept of external economies dates back to the early 20th century. Alfred Marshall, a renowned economist, discussed the significance of external economies in his work, emphasizing how industrial agglomerations result in cost efficiency that benefits the entire industry.
Applicability and Implications
External economies play a crucial role in public goods and government regulation. Since the producers of these benefits are not compensated, markets tend to underprovide such goods, necessitating government intervention to ensure adequate production and distribution.
Comparison with External Diseconomies
External Economies vs. External Diseconomies
External economies contrast with external diseconomies, the latter being costs imposed on third parties by economic transactions. For instance, pollution from a factory imposes health costs on nearby residents, representing a negative externality.
Related Terms
- Public Goods: Goods that are non-excludable and non-rivalrous, often associated with external economies as they benefit society as a whole.
- Market Failure: A situation where the free market does not allocate resources efficiently, often justifying regulatory intervention to correct externalities.
Frequently Asked Questions
What is an example of external economies in public infrastructure?
Public parks enhance the environmental quality and recreational opportunities, benefiting nearby residents and property values irrespective of their contribution to the park’s funding.
How do external economies affect market outcomes?
They often lead to market failures where beneficial outcomes are underproduced compared to societally optimal levels, justifying government subsidies or incentives.
Can external economies justify policy intervention?
Yes, to ensure optimal supply of societal benefits, policies such as subsidies, public provision of goods, and regulation of activities can be implemented.
References
- Marshall, Alfred. “Principles of Economics.” Macmillan and Co., Ltd, 1890.
- Pigou, Arthur Cecil. “The Economics of Welfare.” Macmillan and Co., Ltd, 1920.
Summary
External economies represent significant beneficial impacts resulting from market activities that extend beyond the immediate buyer-seller nexus to third parties. These positive spillovers underscore the necessity for awareness and policy measures to maximize societal welfare and curb underproduction inherent in free-market scenarios.
