Externalities

When one speaks in the national economy of so-called externalities, one basically means economically oriented decisions of companies that unintentionally hit uninvolved market participants.

The person causing the damage, ie the company here, does not compensate. The injured and uninvolved market participants are therefore not awarded any compensation for the inconvenience caused.

As a result, the cessation of the companies that accept such externalities is quite egotistical and only aimed at the highest possible profit. Social and ecological goals remain completely ignored. But what kinds of externalities are there in the economy and what could be practical examples?

Types and Examples of Externalities

In principle, an externality can be positive or negative. Not every externality has to be bad at the same time. A negative external effect is the so-called external cost. In rare cases, however, externalities can also be positive. Then one speaks of an external benefit .

There are countless examples of externalities that are often associated with the environment and with health.

For example, a coal-fired power station produces energy and as a waste product, pollutants are released during production, which are simply released into the environment. The inhabitants of the coal-fired power station could be harmed in health and need treatment. The costs that must be spent on the health recovery of the residents are the external costs. Under normal circumstances the coal-fired power station does not pay these costs, which is why it is an external effect, or more precisely an external cost.

Another example: a motorway is expanded by two additional bumpers and residents are bothered with additional noise by passing cars. If an appropriate noise barrier is built, it is an external effect. The highway is used by countless car and truck drivers. None of them paid for the noise protection.

Development of Externalities

If a company has to keep an eye on the costs of its production, ecological and social objectives are completely ignored. The social costs are, for example, passed on to society through the egoistic approach of the victims. A (financial) compensation does not take place. Since a large part of the companies almost always have the highest possible profit in mind, it often happens that externalities hit the company and thereby damage.

Amount of External Costs

The real difficulty is the exact amount of the external costs. In general, it is very difficult to define the amount of external costs. First of all, it is extremely difficult to find out which costs are an external effect and which costs would arise in any case. As a result, it is usually very difficult for the state to determine the cause for the externalities.

Externalities mean Market Failures

If there is externalities in an economy, you can basically say that the price mechanism has failed . As a result, a market failure occurs and the state is more or less compelled to intervene in the event. Especially in a social market economy, it is ultimately impossible for a company to simply harm other market participants, such as the company or other companies, without a corresponding compensation. In principle, here too, of course, the polluter pays principle applies: The person responsible for the externalities must be held accountable and justified for his actions.

Briefly Summarized:

• Externalities affect uninvolved market participants


• Externalities are basically a form of market failure as the price mechanism has failed


• Externalities can only be very difficult to assign to the polluter


• The amount of externalities can usually only be estimated


• There are positive and negative externalities
  


• Causes of externalities are mostly companies with particularly pronounced profit orientation

Perfect Competition

The principle of perfect competition is a theoretical idea in the economy, which in this form will probably not exist in the longer term.

In order for the condition of perfect competition to be fulfilled, certain conditions must be fulfilled. Both supply and demand are balanced in this market. It is assumed that there are always enough buyers who want to buy the product. At the same time, it is assumed that the supplier does not have to go under his price pain threshold because the demand is permanently high enough.

But what are the prerequisites for full competition and why is this form of competition so remote and therefore just a theoretical model?

Conditions for Perfect Competition

Complete competition requires that no company involved in the market has a market power and that no company has a significant impact on market prices . Moreover, a condition that must be fulfilled is that it must be homogeneous goods. This means that the products of the different suppliers are nearly identical and comparable to the customers. Not many products meet this requirement. An exception could be gasoline, for example. Because the quality of the fuel of a variety is always the same, it does not matter to the customer where he buys the product. The reality, however, is that most of the goods are not homogeneous, since there are, for example, differences in quality.

In addition, there must be a large number of suppliers and buyers in the competition. The consequence of this is that the action of the individual has no influence on the market price. If, for example, there are 1,000 vendors and a million customers, it is irrelevant whether there are only 999 vendors and 998,000 vendors in the next month. The situation would be different if there were only ten suppliers for the number of customers. Then a vendor would more or less have an influence on the market price.

The last condition, which must be fulfilled in perfect competition, is the market transparency , which must be present. This means that every market participant must know which goods are offered and demanded by whom and at what price. A truly theoretical assumption, which in reality is mostly only fulfilled on the stock exchange .

Reality of Perfect Competition

Since one can only speak of a complete competition, if all of the above-mentioned conditions are fulfilled without exception and in full, this model is to be described as very realistic. In reality, it would not be possible. This is much more a theoretical model, an ideal.

Briefly Summarized:

• Perfect competition is a theoretical and realistic ideal


• It is assumed that these are homogeneous, comparable goods (for example gasoline)


• It is assumed that there are a large number of buyers and sellers


• It is assumed that there is a complete market transparency.