Economic Spillover

General Examples of Externalities

Examples of externalities abound in the healthcare market. The market for immunizations is one example of a positive externality. While an immunization prevents or reduces the risk of an individual contracting a disease, it has an additional benefit of protecting the immunized individual from spreading the disease to other members of society. When an individual makes a decision about whether to obtain an immunization, however, he makes this decision based on his marginal cost of the immunization compared with his marginal benefit of preventing himself from contracting the disease. Because spreading the disease to others bears no cost to the individual, it is not a factor in his decision. From the societal perspective, too few people will obtain immunizations if they bear the full cost.

An example of a negative externality relates to smoking. Smoking generates secondhand smoke, which imposes health costs on others. The smoker, however, does not bear the health costs borne by others. Another type of consumption externality exists if one individual's utility or satisfaction depends on another individual's utility. Individuals may, for example, benefit from knowing that everyone in society has access to healthcare.

Medical education provides another positive externality to society, because a community benefits from the human and health capital generated by physicians. Medical education is often heavily subsidized. For example, Medicare subsidizes teaching hospitals through graduate medical education and disproportionate share payments, decreasing a teaching hospital's marginal cost of training residents and ultimately increasing the number of residents trained.

Research and Development

Research and development also generate externalities in society. Research increases the overall level of knowledge in society, and often, the results of research created by one individual or firm are freely used by other entities. Without government grants and subsidies to encourage research and development, too little research would likely be generated, since the individual or firm creating the new knowledge does not reap all the benefits of the research.