Externalities

Broadly speaking, externalities (also known as “spillovers” or “neighborhood effects”) refer to “uncompensated welfare impacts,” that is, the actions and events of one party or person that affect the welfare (positively or negatively) of another without some type of remuneration. These arise when a decision maker does not reap [Page 1069]all the rewards or bear all the costs of his or her actions and can occur in both the production and the consumption of goods and services.

Positive externalities improve the welfare of an individual or group without a cost. For example, if one's neighbor has an attractive garden or plays music that one enjoys, the receiving party derives benefits without paying the costs. Most positive externalities are relatively trivial. However, network externalities, which reflect the ...