ABSTRACT
An externality occurs when all the benefits or costs associated with the production or consumption of a good are not reflected in the market price. Pollution is an example of a negative externality. When a firm produces paper, emitting pollutants into the air, the firm’s costs would not include the effects of this pollution on the economy. The existence of externalities implies additional costs and benefits associated with trade. If a country begins importing a good with a negative production externality, the decrease in domestic production reduces pollution, providing a benefit to the economy. If the good in question is an export good, trade encourages production and greater pollution.
