Externalities can either be positive or negative. A positive externality occurs when a person’s activity creates benefit for uninvolved bystanders (Liebowitz & Margolis, 1994). A compelling example is whereby somebody undergoes vaccination for a contagious disease. This vaccination will not only reduce his/her chances of developing the disease but will also lead to other people having lower chances of contracting the disease. A negative externality occurs when a person’s activity creates loss for uninvolved bystanders, either in the production or consumption (Liebowitz & Margolis, 1994). An example of a negative externality is whereby a factory during production causes the emission of harmful gases to the environment. This causes air pollution increasing the risk of health problems to the surrounding community.

Therefore, externalities will lead to situations whereby there is overproduction of goods with a negative externality while there is overproduction of goods with a positive externality. Coasean theorem implies that the market can solve externalities if property rights are clearly assigned and negotiation is feasible. It attempts to describe the economic efficiency of an economic allocation where externalities are present (Liebowitz & Margolis, 1994).

A Coasean solution will not resolve the economic efficiency of the positive externality mentioned that is vaccination. This is because there are no clear rights assigned to the people around the vaccinated person. In this case, negotiation would also not be feasible. The same case also applies to the negative externality cited of pollution by a company. This is because, although the entire population owns the air, all citizens cannot simultaneously negotiate about pollution levels. Therefore, negotiation in this case is not feasible and, the market cannot solve the externality.

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