External effects

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External economic effects are changes in welfare due to an urban development project with which the owners, exploiters and users are not taking account of during the decision process. Put differently, external effects are benefits and costs which arise when the social or economic activities of one group of people have an impact on another, and when the first group fails to fully account for their impacts[1].


External costs are related to the principles of welfare economic, and refer to the idea that activities developed by a certain party can adversely affect the well-being of a third party, e.g. the next door neighbors of a nuclear power plant.

By definition, private markets do not include external effects or their costs in their investment projects. It is therefore important to identify the external effects and then to monetise the related external costs, for example, with the help of a Social cost-benefit analysis. This so-called "internalisation" of external effects has to be achieved by adequate policy measures, such as taxes.

Types of external effects

Externalities can be classified in two main categories:

Kivioli chemical plant
  • Environmental and human health externalities: "These can additionally be classified as local, regional or global, referring to climate change caused by emissions of CO2 or destruction of the ozone layer by emissions of CFCs or SF6" [2].
  • Non-environmental externalities: "Hidden costs, such as those borne by tax-payers in the form of subsidies, research and development costs, or benefits like employment opportunities, although for the latter it is debatable whether it constitutes an external benefit in the welfare economics sense"[2].

External effects can be both a primary or a secondary impact.

Related subjects

Footnotes and references

  1. European Commission (1994): Common Market Expert Group, The Economic Cost of Traffic Accidents.COST 313.
  2. 2.0 2.1 The European Wind Energy Association (EWEA). Wind Energy; The Facts. Online: http://www.ewea.org/eu-funded-projects/completed-projects/wind-energy-the-facts-ii/