Understanding Positive Externality and Its Impact on Business

The concept of externality has received a lot of attention over the last several decades, primarily due to the ongoing concerns over changes in climate and increased globalization. All too often, those discussions focus on negative externalities, as actions taken by governments and businesses can have a negative effect on the environment, national economies, and groups of people. But what about positive externality and those sometimes unexpected benefits that can occur?

In this post, we will explore the concept of positive externality. We will also examine how business decisions can often create beneficial externalities for the economy and people. Finally, we will offer some advice to help managers and other leaders who may need to consider potential externalities in their decision-making processes.

What is a positive externality?

In simple terms, externalities represent the impact third parties experience as a result of any given action. As noted in our introduction, negative externalities receive the greatest amount of public attention, as the media and others routinely focus on the bad effects companies, governments, and private individuals may have on the world around them. For our purposes, we want to focus on positive externality, and the way in which third parties can benefit from various business decisions.

In business, these positive externalities are defined as either consumption or production externalities. Consumption benefits are those positive effects people in society receive from the consumption of goods by other individuals, government, and private business. Meanwhile, the externalities associated with production involve benefits that society and individuals receive from the production of goods and services.

It is important to note that businesses may not always consider all of the positive externalities of production, since companies focus most of their attention on satisfying the needs and desires of their target market. Since they are profit-driven and receive no compensation for those externalities, there is not always a reason for them to spend an inordinate amount of time thinking about those effects. Still, most companies do invest at least some effort in identifying how their products and services positively impact everyone—which often helps to inform their marketing and advertising strategies.

What are some examples of positive externalities?

To better understand positive externality, it is helpful to consider some examples of how decisions and actions can impact third parties. Consider the following positive externalities flowing from various acts of consumption and production.

Consumption-based positive externalities

Quality home design and construction. While the creation of a new home primarily benefits the builders and home buyers, there are also unintended benefits for others who live in the neighborhood and anyone who drives by. For example, a new and beautiful home can improve home values in the area, provide a pleasant visual for neighbors and people passing by, and even add to a city’s tax revenue.

Education costs. When children and adults receive an education, society benefits from the addition of new skilled workers. That education can also help people to avoid behaviors and situations that can lead to crime or other social ills. Advanced education often spurs new innovation, which can produce even greater positive externalities for others as new products, services, and ideas are created.

Shopping in malls and concentrated business districts. When shoppers visit a store inside a mall or in an area with multiple businesses, those other companies can benefit from the traffic.

Advertising. Companies that purchase advertising are directly consuming market resources to connect with their target markets. Buying those ad spots from local television networks, Twitter, YouTube, and other similar platforms helps to fund those businesses and allow them to provide their services to other consumers free of charge.

Production-based positive externalities

A few examples of potential positive externalities on the production side of the equation can also be useful for understanding these concepts. Some examples of how third parties can benefit from production decisions and actions include:

Investment in construction. When companies build new homes or commercial properties, that not only benefits the builders and potential buyers, but also provides an array of benefits to other parties. For example, the building effort provides jobs that benefit not only the employees doing the work, but their neighbors and the businesses that provide them goods and services.

Those benefits help to stimulate even greater economic activity throughout the community.

That construction can also raise property values in the area. When commercial property is being built, that can inspire other businesses to locate in the community, providing even more jobs and benefits to the people who live there.

Company training of employees. Companies typically invest a great deal of time and resources training new employees. As they do so, they can create positive externalities for society as a whole, as well as any other company that might hire their employees in the future. As employees learn new skills or new ways of doing things, they become more valuable and productive members of society. That added value can contribute to the overall productivity of their business, but also their industry and the nation as a whole.

Technological innovation. Technological advancement always provides unexpected benefits for third parties. Take the NASA space program, for example. As the nation’s space agency worked to develop new technologies to place humans in space, those technologies eventually bled over into civilian society. The space program did extensive research into various fields of study to ensure that those people could be launched into space and returned safely. As a result of that research, people around the world have received benefits like:

The development of an artificial heart that was based on the technology used for space shuttle engine fuel pumps
GPS developed by NASA that is now used to aid pilots flying in U.S. airspace
Ground cleaning technology developed for NASA that is now used to help clear up underground pollution that threatens water systems
Robotic arms used to service spacecraft that have been adapted for surgical use
Advancements in dietary formulas, solar panels, search and rescue systems, and more

How businesses can leverage positive externalities

As mentioned earlier, there is no way for most businesses to receive compensation for those third-party benefits. In addition, it is important to note that consumption-based externalities can even put stress on businesses, since most consumers do not make buying decisions based on how those choices might benefit others. As a result, goods and services that can provide those third party benefits may not be produced to the degree necessary to provide the most potential benefit to society.

One way that managers and other leaders in the business world can offset potential underproduction is by promoting those benefits in their marketing and advertising efforts. This is particularly relevant in the current social climate since there are so many organizations raising awareness about various social ills. Business leaders who understand this can use advertising to great effect, educating their customers and the rest of the public about how their products and services can benefit everyone and contribute to society in a positive way.

Summary

A positive externality is created any time an act of production or consumption provides benefits to a third party who is not involved in the transaction. A greater understanding of this aspect of business and economic activity can help leaders and managers to be more effective in their decision-making.

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Written by

Ken Chase, Freelance Writer

During Ken's two decades as a freelance writer, he has covered everything from banking and fintech to business management and the entertainment industry. His true passion, however, has always been focused on helping others achieve their career goals with timely job search and interview advice or the occasional resume consultation. When he's not working, Ken can usually be found adventuring with family and friends or playing fetch with his demanding German Shepherd. Read more resume advice from Ken on ZipJob’s blog.