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Chapter 7 Externalities
When the person sitting next to you lights up a cigarette, he gets nicotine and the cigarette company gets some of his money. You just suffer, with no compensation. If your neighbor’s house catches fire because he fell asleep with that cigarette burning in his hand, your house may burn to the ground. The neighbor on the other side who plays very loud music late into the night—before your big economics test—enjoys the music, and the music distributors gets his money. You flunk out of college and wind up borrowing $300,000 to buy a taxi medallion. Drunk drivers, cell phones ringing in movie theaters, loud automobiles, polluted air, and rivers polluted to the point that they catch fire, like Cleveland’s Cuyahoga did, are all examples where a transaction between two parties harmed other people. These are “external effects.”
But external effects are not necessarily negative. The neighbor who plants beautiful flowers in her yard brightens your day. Another person’s purchase of an electric car reduces the smog you breathe. Your neighbor’s investment in making his home safe from fire conveys a safety advantage to you. Indeed, even your neighbor’s investment in her own education may provide an advantage to you—you may learn useful things from your neighbor. Inventions and creations, whether products or poetry, produce value for others. The creator of a poem or a mathematical theorem provides a benefit to others.