To state it differently, producers of education are not fully compensated for the benefits that spill over to society.
Although education has many spillover benefits, providers of education do not receive all the revenue they would earn if the full benefits of the transaction were internalized. In addition, more education leads to higher worker productivity and higher living standards for society in general.
Also, regions with a more-educated population tend to have lower crime rates. For example, a well-educated society is more likely to make good decisions when electing leaders. In other words, you can generate positive externalities. The many benefits of your education spill over to society in general. Although you might think you are the only one who benefits from your education, that isn't the case.
A technical degree or college education will further enhance those benefits. When you complete high school, you'll reap the benefits of your education in the form of better job opportunities, higher productivity, and higher income. As a result of the higher cost of production, the firm will reduce its production of widgets thus reducing the level of pollution. The government could place a 20 cent tax on each widget produced to ensure that the firm pays the actual cost of production-which is now two dollars and twenty cents, including the cost of the negative externality. For example, let's assume the cost of producing the widgets noted earlier is two dollars per unit, but an additional 20 cents per unit had been shifted to society as a negative externality in the form of dirty air. The use of such a tax is called internalizing the externality. So, such taxation attempts to make the producer pay for the full cost of production. The higher cost, then, better reflects the true cost of production because it includes the spillover costs of, say, pollution. This taxation effectively increases the cost of producing such goods. Government can play a role in reducing negative externalities by taxing goods when their production generates spillover costs. And since more widgets are being produced, more air is being polluted. So, ultimately, more widgets are produced than would be the case if all costs were included. Consumers will buy more widgets at the artificially low price than at a price that reflects their full production cost. And, because the firm isn't paying the full cost of producing widgets, the price charged for widgets is artificially low. So, in this case, pollution represents the shifting of some of the cost of production to society, a negative externality. Instead, if society wants clean air, society must pay to clean it. If the firm were paying the full cost of production, it would return clean air to the atmosphere. How? Well, in its production process the firm uses clean air-a resource it does not pay for-and returns polluted air to the atmosphere, which creates a potential health risk to anyone who breathes it. From an economic perspective, the firm is shifting some of its cost of production to society. The smokestacks at the factory, however, belch out pollution 24/7. Imagine there's a factory in your town that produces widgets, a good that benefits consumers all over the world. So, externalities occur when some of the costs or benefits of a transaction fall on someone other than the producer or the consumer. A positive externality occurs when a benefit spills over. A negative externality occurs when a cost spills over. These spillover costs and benefits are called externalities. However, sometimes, costs or benefits may spill over to a third party not directly involved in the transaction. For example, when you buy a doughnut at the store, it's reasonable to assume all the costs and benefits of the transaction are contained between the seller and you, the buyer. When markets are functioning well, all the costs and benefits of a transaction for a good or service are absorbed by the buyer and seller. All three are actually examples of economic transactions that include externalities.
What do pollution, education, and your neighbor's dog have in common?
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