Externalities – including the true cost of activities

The concept of externalities is an important part of economic theory.  Some negative externalities are not only recognised but legislation exists to limit their impact.  Examples include water pollution and some noise pollution. However, there are various examples of where the negative externality exists but is  not dealt with. 

 

If we look at the basic model of a business or activity it consists of the various costs involved in the production of a good or service – labour, parts, other costs incurred. A charge is then made on the user of the product to cover costs and to make a profit. Very straightforward.

 

But the model ignores the other costs imposed on society and the environment.  For instance if an agricultural enterprise results in pollution in waterways; greenhouse gas emissions from vehicles and aircraft; health costs due to noise pollution. Music events are a good example of the problem.

 

Let us say it costs £100,000 to run an event.  Revenue is £120,000.  A profit of £20,000.  But if we included externalities what would the cost/benefits look like?

 

Let us say congestion costs are £5,000 and the loss of wellbeing for local residents due to noise are £15,000 – then the event is not viable.

 

Should we include the cost of externalities? Probably.