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Externalities and Mergers

 Discussion Question 1: Externality

An externality is an uncompensated impact of an entity’s actions on the welfare of a third party or bystander (Mankiw, 2010). It can have either positive or negative effect. A positive externality is where the impact on the bystander is beneficial while it is negative when the effect is adverse. In the presence of externalities, the interests of the society go beyond the welfare of buyers and sellers. Examples of externalities include exhaust from automobiles, Barking of dogs, and research into new technologies. The exhaust from automobiles is an example of a negative externality. It creates smoke that people have to breathe. As a consequence of this externality, drivers tend to pollute too much.  Government responds to this problem by setting emission standards for cars. It may also tax petrol to reduce the tendency of people to drive frequently. In many cases, the government’s solution helps reduce the impact of a market failure. However, it may sometimes enhance the problem. For example, imposing tax rather than a ban on a dangerous activity will encourage the failure.

 Discussion Question 2: Mergers

There are three types of mergers: horizontal, vertical, and conglomerate (Mankiw, 2010). A horizontal merger is a merger that involves two competitors such as Coca Cola and Pepsi.  On the other hand, a vertical merger occurs when a supplier buys a seller or vice versa, i.e. companies on the same supply chain.  An example of a vertical merger is integration involving a pharmaceutical manufacturer and a distributor. A conglomerate merger involves integration between firms that are not on the same supply chain and are not competitors. An example of a conglomerate merger is a food company buying a finance company. The government should apply antitrust laws to control mergers. Antitrust laws apply broadly and focus on maintenance of the basic rules of competition. It encourages competitive interactions among firms and create favorable outcome.


Mankiw, G.N. (2010). “Principles of Economic”. Mason, OH: South Western Cengage Learning


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