Define Externalities. Present a brief about types of externalities. Explain how internalisation of negative externalities could be a solution to externalities through the instruments of taxation and property rights

Externalities are unintended side effects of economic activities that affect third parties who are not directly involved in the activity.

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There are two main types of externalities: positive externalities, where the side effects are beneficial, and negative externalities, where the side effects are harmful.

Negative externalities occur when the costs of an economic activity are borne by individuals who did not choose to incur them. Examples include pollution from a factory affecting the health of nearby residents or noise from construction disrupting neighboring households.

To internalize negative externalities, two common instruments are taxation and property rights. Taxation involves imposing a tax on the polluting activity, effectively increasing its cost to the firm. This encourages businesses to reduce pollution to avoid higher taxes. Property rights entail assigning ownership of certain resources affected by externalities, like air or water quality, to individuals or communities. This gives them the right to take legal action against those causing harm and provides an incentive for polluters to mitigate negative effects.

These measures aim to align private incentives with social costs, ensuring that those responsible for externalities bear the consequences and encouraging more socially responsible economic behavior.