William engages in an activity that influences the well-being of a bystander. In which of the following instances does an externality arise?
A)The impact of William's activity on the bystander is adverse, and William compensates the bystander accordingly.
B)The impact of William's activity on the bystander is adverse, but William fails to compensate the bystander.
C)The impact of William's activity on the bystander is beneficial and the bystander compensates William accordingly.
D)Externalities arise in all of the above cases.

Question

Quizplus · Accepted Answer

An externality arises when an activity of an individual or entity (such as a firm) has an impact on the well-being of a third-party bystander, and the individual/entity does not bear the full cost or receive the full benefit of that impact. In this case, William's activity has an adverse impact on the bystander, but William fails to compensate the bystander for that impact, therefore creating a negative externality. The other choices do not result in an externality, as in A William compensates the bystander, and in C the impact is beneficial and compensated for by the bystander.

William Engages in an Activity That Influences the Well-Being of a Bystander