Reading: What Are Externalities?

Imagine your neighbour gets a massive speaker and loves late‑night music. They’re having fun. But
you’re lying awake, unable to sleep before a math test.

• Your neighbour enjoys the music.

• You pay part of the cost: lost sleep and stress.

You’re not part of the “music purchase” decision at all, but you still feel the effects. In economics, that
“spillover” effect is called an externality.

Basic definition

An externality is a cost or benefit that falls on people who are not directly involved in a
transaction.[1][2]

• If the spillover hurts others, it’s a negative externality.

• If the spillover helps others, it’s a positive externality.[3][4]

You can think of externalities as “side effects” of someone else’s choices that affect you, even though
you weren’t asked and aren’t paid or charged for them.[5][3]

Negative externalities (bad spillovers)

A negative externality is when others pay a cost they didn’t choose. Examples:[6][3]

• A factory emits air pollution. The company and customers benefit from production, but people
living nearby get more asthma and dirtier air.

• Drivers who crowd the roads cause traffic congestion and more emissions, slowing
everyone else down and harming air quality.[4][2]

• At school, someone vapes in the washroom. They feel relaxed; everyone else gets gross air
and health risks.

In each case, the full social cost (to everyone) is bigger than the cost faced by the buyer and seller.
Positive externalities (good spillovers)

A positive externality is when others get a benefit they didn’t pay for. Examples:[7][3][1]

• Education: When you get more education, you personally gain skills and income, but society
also benefits from having a more skilled, informed population (better decisions, more
innovation).[7][1]

• Vaccinations: If you get vaccinated, you reduce your own risk and help protect people around
you by lowering the chance of disease spreading.

• Nice yard or local café: If someone keeps a beautiful yard or a café opens near school,
neighbours enjoy the view, vibe, and convenience, even if they didn’t pay for it.

In these cases, the social benefit is bigger than the benefit to the individual buyer.

Why externalities matter

Markets usually work on private costs and benefits (“What do I pay?” “What do I get?”). Externalities
mean that some costs or benefits are invisible in the price.[2][1]

• With negative externalities, markets often produce too much of the harmful thing (e.g.,
pollution) because not all costs are paid by the producer/consumer.

• With positive externalities, markets often produce too little of the beneficial thing (e.g.,
education), because the buyer doesn’t receive all the benefits society gets.[4][2]

That’s why governments sometimes tax, subsidize, or regulate certain activities—to push private
choices closer to what’s best for society as a whole.[6][4]
Worksheet: Spotting Negative and Positive Externalities

Name: ____________________________ Date: ___________________

Part A – Check your understanding

1. In your own words, what is an externality?

Be sure to mention: someone’s decision, and a third party that is affected.[3][2]

2. What is the difference between a negative externality and a positive externality?

Give one short example of each (your own, not from the reading if possible). [3][4]

Part B – School and life examples

For each scenario, answer the questions.

3. Lunchroom noise

At lunch, a large group starts shouting and banging tables for fun. They are entertained; other students
nearby are trying to finish assignments.

a) Is this a negative or positive externality?

b) Who is the third party being affected?
c) What is the spillover cost or benefit?

4. A student‑run tutoring club

A group of Grade 12 students starts a free after‑school tutoring club for math and science. It helps
people pass classes and raise marks. Some students who never attend still benefit because their group
projects are stronger and the overall class moves faster.

a) Is this a negative or positive externality?

b) Who gains from this even if they never join the club?
c) Why might the private benefit to the tutors be smaller than the social benefit?
 5. Parking and traffic around school

Lots of students drive to school. The parking lot and nearby streets get congested before and after
classes. Neighbours complain about blocked driveways and noise; buses run late because of
congestion.

a) Identify one negative externality of driving to school in this situation.

b) Who pays the cost?
c) If the school only looks at “student convenience,” what part of the social cost is it ignoring?

6. A local gym near school

A new gym opens two blocks from school. Students who join become healthier and miss fewer days.
Even students who never join feel safer walking home at night because there are more people around
and better lighting near the gym.

a) Is the gym creating any positive externalities? Describe one.

b) How does this benefit someone who is not a member?
c) Why might society want more of this kind of investment than the market provides on its own?
Part C – Policy thinking (short answers)

7. For a negative externality like traffic congestion and pollution around your school, name one
policy the school or city could use to reduce it (for example, price, rules, or incentives). Explain
how your idea would change people’s behaviour.

8. For a positive externality like the tutoring club or vaccinations, name one way the school or
government could encourage more of it (subsidy, award, space, information, etc.). Explain
why that might move private choices closer to what’s best for the whole community.

1. [Link]

2. [Link]

3. [Link]

4. [Link]

5. [Link]
social-costs

6. [Link]
government/environmental-regulation/a/the-economics-of-pollution-cnx

7. [Link]

8. [Link]

9. [Link]

10. [Link]

11. [Link]
econ-1-classifying-public-goods-externalities/148251570

12. [Link]

13. [Link]

14. [Link]

15. [Link]
Assignment: Graphing Negative and Positive Externalities

Name: ____________________________ Date: ___________________

Instructions

For each situation below, draw one supply–demand graph showing how externalities change
social costs or benefits compared to private ones. Label axes, curves, and key points clearly.

Use simple, neat sketches; perfection isn’t required, but labels are.

Part A – Negative externality: driving to school

• Scenario

Driving to school is convenient for individual students. But more cars create traffic, noise, and
pollution around the school, which affect neighbours and other road users who are not part of the
“decision to drive.”

• Graph task

a) Draw a standard market for “rides to school by car”:

• Horizontal axis: Quantity of car trips to school per day (Q).

• Vertical axis: Cost/benefit per trip (P).

b) Draw and label:

• Demand curve: 𝐷 = Marginal Private Benefit (MPB).

• Private supply curve: 𝑆𝑃 = Marginal Private Cost (MPC).

c) Now add a second supply curve above the private one to show the extra cost of congestion and
pollution:

• Label it 𝑆𝑆 = Marginal Social Cost (MSC).

d) Mark and label:

3. The market equilibrium (where MPB = MPC): (𝑄𝑚𝑎𝑟𝑘𝑒𝑡 , 𝑃𝑚𝑎𝑟𝑘𝑒𝑡 ).

4. The socially efficient quantity (where MPB = MSC): (𝑄𝑠𝑜𝑐𝑖𝑎𝑙 , 𝑃𝑠𝑜𝑐𝑖𝑎𝑙 ).

5. Use shading or a bracket to show the “overproduction” area (between 𝑄𝑠𝑜𝑐𝑖𝑎𝑙 and 𝑄𝑚𝑎𝑟𝑘𝑒𝑡 ).
 4. Short questions

e) In one sentence, explain why the social cost curve (MSC) is above the private cost curve (MPC) in
this situation.
f) Who is paying the external cost between 𝑄𝑠𝑜𝑐𝑖𝑎𝑙 and 𝑄𝑚𝑎𝑟𝑘𝑒𝑡 ?

DRAW THE GRAPH BELOW

Part B – Positive externality: after‑school tutoring club

5. Scenario

A student‑run tutoring club helps participants pass courses and get into better programs. It also
benefits others: group projects run more smoothly, fewer people repeat courses, and the whole grade’s
performance improves.

6. Graph task

a) Draw a market for “hours of tutoring provided”:

7. Horizontal axis: Quantity of tutoring hours (Q).

8. Vertical axis: Value/cost per hour (P).

b) Draw and label:

9. Supply curve: 𝑆 = Marginal Cost (MC).

10. Private demand curve: 𝐷𝑃 = Marginal Private Benefit (MPB).

c) Now add a second demand curve above the private one to show extra benefits to other students and
the school:

Label it 𝐷𝑆 = Marginal Social Benefit (MSB).

d) Mark and label:

16. The market equilibrium (where MPB = MC): (𝑄𝑚𝑎𝑟𝑘𝑒𝑡 , 𝑃𝑚𝑎𝑟𝑘𝑒𝑡 ).

17. The socially efficient quantity (where MSB = MC): (𝑄𝑠𝑜𝑐𝑖𝑎𝑙 , 𝑃𝑠𝑜𝑐𝑖𝑎𝑙 ).

18. Use shading or a bracket to show the “underproduction” area (between 𝑄𝑚𝑎𝑟𝑘𝑒𝑡 and 𝑄𝑠𝑜𝑐𝑖𝑎𝑙 ).

1. Short questions
e) Why is the social benefit curve (MSB) above the private benefit curve (MPB) for the tutoring club?
f) Give one real‑world policy the school could use (e.g., small subsidy, recognition, free space) to move
the quantity from 𝑄𝑚𝑎𝑟𝑘𝑒𝑡 toward 𝑄𝑠𝑜𝑐𝑖𝑎𝑙 .

DRAW THE GRAPH BELOW

Part C – Reflection (1–2 sentences)

1. In your own words, describe the pattern you see:

1. What happens to quantity when there is a negative externality?

2. What happens to quantity when there is a positive externality?

(You don’t need a graph here—just words.)