Production externalities occur when a production unit produces social, environmental, or economic side effects or byproducts with side effects. These externalities can include both positive and negative impacts.

In this article, you will learn about production externality, its positive and negative impact, and understand how to manage them to optimize [manufacturing] procedures. With the right strategy and planning, businesses can contain byproducts and make production more profitable.

What Are Production Externalities?

Production externality is the unintentional side effect of manufacturing or production operation. These include economic, social, and environmental side effects. Due to these by-products, the [production process] can not be produced at its maximum capacity, generating unintentional wastage.

A positive production externality is the unintentional positive effect of a company's industrial process, while a negative production externality includes adverse side effects on any third party. The production externality's impact can be positive or negative, and/or sometimes a combination.

Understanding Production Externalities

There are many ways to understand [production] externalities better. Here is an example:

Imagine an electrical manufacturing unit that produces electronic components.

The production process might release certain pollutants into the air, leading to environmental degradation and health issues for the nearby community. As a result, the government might impose stricter regulations and higher penalties for increased pollution levels.

In this scenario, the cost of producing more electronic components could rise significantly, potentially exceeding the unit's profit margins.

However, not all production externalities are negative.

For instance, while producing these electronic components, the manufacturing unit might also generate a by-product that can be used as a sustainable energy source. This by-product, similar to, for example, ethanol in other industries, could benefit the environment and serve as an alternative energy solution.

So, while some production processes can lead to negative externalities like pollution, others might result in positive outcomes, such as the creation of valuable by-products. Industries need to recognize and manage these externalities to ensure sustainable and responsible production.

Read Also: [Cost of goods sold (COGS)]

Examples of Positive Production Externalities

A positive production externality is an external benefit or beneficial externality with an unintentional positive environmental impact. These externalities create the byproduct which is a useful element that has a positive impact on society or an unrelated third party.

For example, the positive externality is a farmer who produces honey using honey bees. These bees, along with honey, also contribute to pollination. The value generated from pollination is much higher and more significant than the actual cost of harvested honey. In this scenario, pollination is an external benefit for the farmer.

Similarly, a company providing health care workshops can help its workers outside the factory. Some companies offer healthcare workshops that teach workers about first aid and steps to take if a coworker needs help. These workshops spread awareness among workers and help their families in crisis. These first aid and healthcare tips are helpful for low-income families who lack the funds to visit a doctor even in an emergency.

Read Also: [How to Create an Inventory List in Microsoft Excel: Step-by-Step Guide]

Examples of Negative Production Externalities

A negative production externality is a negative byproduct of a production that affects society or the environment, which is unintentional. Examples of byproducts of negative [production] externalities include:

• Paper mills that dump waste in river bodies.

• Noise pollution in factories due to the use of heavy machinery can create sleep deprivation and other medical side effects for workers.

• An unhealthy and dangerous work environment can impact the workers' families and affect every individual in contact with the worker.

Production Externality vs Consumption Externality

Production externalities occur when a product is produced, while consumption externality occurs when customers use or consume the product. A product can have a consumption externality but no production externality. For example, a cosmetic product might cause a rash when applied on sensitive skin but doesn't produce any byproducts that affect the environment. It is an example of a consumption externality.

In contrast, a product can have a product externality but no consumption externalities. Examples of production externalities include the production of honey bees. The consumption of honey has no side effects but positively affects production due to pollination. Some products can have both or their combination as well. The other main difference is that production externalities are unintentional, while consumers are aware of consumption externalities.

Read Also: [Inventory Financing: Definition, How It Works, Pros, and Cons]

Manage Production Externalities With TranZact

[TranZact] helps businesses identify the externality of production and manage it to reduce its negative impact. With the right strategy, companies can reduce negative externalities and utilize external benefits to enhance profits. With TranZact, companies can grow sales exponentially while keeping byproducts and harmful side effects in check.

FAQs on Production externality

1. What is the difference between production externality and negative consumption?

Negative consumption occurs if a consumer gets adverse side effects after using a product, while production externalities include both positive and negative side effects during the production of the product.

For example, a shampoo that gives a rash to dry scalps is an example of negative consumption. If the production of this shampoo also pollutes the environment by discharging chemicals into water bodies, that is an example of a production externality.

2. What happens if there are negative externalities in production?

Negative externalities can harm the environment and society with its negative impacts. It is the unintentional by-product of manufacturing a product and can harm the environment if emitted into the atmosphere.

When negative externalities and the production of goods are connected, the market output becomes higher than the optimal or expected output. For example, a production process causing noise or pollution harms the environment and is an example of negative externalities of production.

3. Is pollution an externality in the production process?

Yes, pollution can be an externality in the production process. It falls under negative production externality. If any harmful chemical or solution is released into the air, water, or soil during the production process, it leads to pollution in the atmosphere.

4. How can production externality affect production?

The production externality is the cost or benefit that occurred unintentionally during any production process. It can have both positive and negative side effects. Positive externalities lead to underproduction of goods, while negative externality causes overproduction.

For Example, a skill training workshop impacts workers positively and encourages them to learn more skills. It is an example of a positive production externality. On the other hand, the negative production externality includes water, air, or noise pollution produced during the production of goods.

5. How do you fix the negative externality of production?

Negative externalities are reduced with the help of higher taxes on the production of goods that cause pollution or other harmful impact. If a company produces goods with dangerous side effects, the government should add a checkpoint to control its release. Government bodies also discourage negative externalities by imposing a Pigovian tax that can generate spillover benefits.

6. What is an example of production and consumption externalities?

Pollution is an example of production and consumption externalities. For instance, if a chemical factory generates harmful fumes and disposes of untreated chemicals in water bodies, it can negatively impact the environment and affect third parties. Also, water consumption from such water bodies can cause multiple diseases.