Private solutions to correct for externalities Consider the following scenario: Suppose that a cafe enjoys a large increase in customers whenever the jazz club next door features a band playing appealing music, because it can be easily heard from the cafe. The jazz club owner decides to purchase the cafe so that he can internalize this positive externality. Which of the following types of private solutions to the externality of appealing music has occurred in this case? It's important to note that sometimes private solutions to externalities do communications barriers or social customs are important enough relative to the potential gains involved that

Externalities occur when the production or consumption of a particular good or service affects a third-party who is not related to the transaction. A positive externality is one that is favorable and beneficial to the third party and a negative externality is one that is unfavorable and creates a cost to the third party. In this case, the third party is the owner of the cafe and it is a positive externality because the music creates an increase in the number of customers to his/her business.

When the jazz club owner purchases the cafe, the cafe becomes his. Hence, the benefit felt to the cafe by the music from the jazz club is a benefit that his own new business incurs. Thus, the integration of these two businesses into one helps internalize the positive externality since now the main party involved in the transaction is also the one feeling the positive externality.