Crawl Across the Ocean

Saturday, March 14, 2009

2. Actions, Transactions and Externalities

Note: This is the second in a multi-part series, part 1 here.

In the first installment I forgot to mention that in addition to summarizing a bunch of books/arguments, I was also going to need to make a few posts here and there explaining some of the terms and concepts used in these books. This post covers the concepts of actions, transactions and externalities.


For the purposes of this series of posts I want to use the word 'action' to mean those activities primarily involving just one person (e.g. I go into the orchard and pick some fruit, I decide to go back to school, I decide to save money rather than buying a new car) and 'transaction' to mean activities that primarily involve two people (e.g. I pay my tuition to a college, I steal a fruit from my neighbour etc.) Naturally there’s some grey area in these definitions but I think the distinction between actions primarily involving just one party and transactions involving two parties is clear enough to be useful.

The next concept I want to mention is the idea of an externality. This is a term primarily used in economics, but there's nothing specifically 'economic' about it. All it refers to is the idea that an action or transaction might have an impact on other parties that were not part of the original action/transaction.

Where those impacts are negative, we refer to a negative externality, where those impacts are positive, we refer to a positive externality.

For example I drive to the car dealership to buy a new car. I have an action (driving to the dealership) and a transaction (exchanging my money for the car) with the salesman. But there are impacts of this action and transaction on other parties besides myself and the car salesman.

By driving there, I am releasing carbon dioxide into the atmosphere that may damage the climate and cause harm to people who had nothing to do with me driving to the car dealership – this is a negative externality.

On the other hand, perhaps I have friends and family members who used to always need to give me a ride places and now I can drive on my own or give them rides – so my car purchase contains a positive externality for these people.

On the other (other) hand, my neighbours may now derive less satisfaction from their car because I have a newer, fancier car then they do and they may feel the need to go buy a better car of their own – so there is a negative externality for them. And so on.

It’s a simple concept, but a very important one, so I wanted to explain it as clearly as possible before we continued on.

For more on externalities, here is the excellent wikiepdia entry, which has a number of examples, goes into more detail on a number of interesting fronts and defines an externality as follows:
'In economics, an externality or spillover of an economic transaction is an impact on a party that is not directly involved in the transaction. In such a case, prices do not reflect the full costs or benefits in production or consumption of a product or service.'

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