What exactly is the difference between a production and consumption externality?

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Hi, my classmates and I were having a discussion on what exactly constitutes a "production externality" and a "consumption externality". In our class notes, we were given the following definition of a "consumption externality": when a consumer cares about the consumption or production activities of other agents in society. And as an example of this, we were given the following scenario: when the burning of crop stubble by rice farmers affect residents living a city nearby due to the air pollution generated.

My issue with this was that, if the pollution is generated as a result of a rice farmer's production activity (i.e. the burning of the crop stubble to clear the land for his next harvest), then how can it be considered a "consumption externality"? Isn't a consumption externality a side effect (which can be good/bad) that results from a consumption activity and not a production activity? Likewise, isn't a production externality a side effect (which also can be good/bad) that results from a production activity?


Yes, it is as you say. A production externality is generated when the production activities of one firm adversely or positively affects the production activities of another firm. Similarly, a consumption externality is generated when my consumption of a good affects your consumption of the same. The example of burning of crop stubble is interesting because while it is a production-related activity, it does not (I think) affect the production activities of a firm in the city. But it does, via the pollution generated, affects the ability of a city resident to enjoy the outdoors. In my view, the example of burning crop stubble is neither a production or a consumption externality by their strict definitions. An example of a production externality would be: Musician A's playing the guitar releases so much sound that Musician B cannot play the guitar at the same time. 

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Last updated on October 6, 2022