Correcting Externalities

9 Key excerpts on "Correcting Externalities"

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  Public Finance and Public Policy

  A Political Economy Perspective on the Responsibilities and Limitations of Government

  • Arye L. Hillman(Author)
  • 2019(Publication Date)
  • Cambridge University Press

    (Publisher)

  It is important to recognize that taxes and subsidies do not have a necessary association with respective adverse and bene fi cial externalities. Rather, whether a tax or subsidy is called for depends on legal rights (as with the Coase Theorem where, in private negotiations, legal rights determine who pays whom). Taxes and subsidies to correct externalities are shown in Figure 4.6 , where there is an adverse externality (environmental damage, for 27 Arthur Cecil Pigou (1877 – 1959), writing in The Economics of Welfare (1962 [1920]), proposed that taxes or subsidies should be used to correct externalities. The taxes and subsidies named after Pigou are called Pigovian. 4.4 Public Policy to Address Externalities 149 example) due to the output of an industry. 28 Either a tax or a subsidy can in principle move the market outcome in Figure 4.6 from the inef fi cient outcome at point F to the ef fi cient outcome at point E . 29 A Corrective Tax The ef fi cient corrective per-unit tax t in Figure 4.6 is AB = EH , which is the difference between true and private MC at the ef fi cient output Q E . The tax is paid on each unit of output produced up to Q E . By paying the per-unit tax t , producers internalize the externality in their production decisions. Producers choose output as if a market for the right to pollute existed. The tax t is paid in place of the price that producers would pay if there were a market for the right to pollute. A tax presupposes that “ society ” has the legal right to impose a penalty or price for environmental damage. 30 X O Q E G J F V H E D s = t B A S ′ = Σ true MC S = Σ private M C Demand Q C Output Value of cost and benefit Figure 4.6 The use of a tax or subsidy to correct an externality 28 Market demand is D .

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  Fundamentals of Environmental Economics

  • Kumar, A(Authors)
  • 2021(Publication Date)
  • Daya Publishing House

    (Publisher)

  Public-Sector Remedies for Externalities In the United States, public policy makers do not think that Coasian solutions are sufficient to deal with large-scale externalities. The Environmental Protection Agency (EPA) was formed in 1970 to provide public-sector solutions to the problems of externalities in the environment. The agency regulates a wide variety of environmental issues, in areas ranging from clean air to clean water to land management. Public policy makers employ three types of remedies to resolve the problems associated with negative externalities. Corrective Taxation We have seen that the Coasian goal of “internalizing the externality” may be difficult to achieve in practice in the private market. The government can achieve this same outcome in a straightforward way, however, by taxing the steel producer an amount MD for each unit of steel produced. Figure 5 illustrates the impact of such a tax. The steel market is initially in equilibrium at point A, where supply (= PMC 1 ) equals demand (= PMB = SMB ), and Q 1 units of steel are produced at price P 1 . Given the externality This ebook is exclusively for this university only. Cannot be resold/distributed. with a cost of MD, the socially optimal production is at point B, where social marginal costs and benefits are equal. Suppose that the government levies a tax per unit of steel produced at an amount t = MD. This tax would act as another input cost for the steel producer, and would shift its private marginal cost up by MD for each unit produced. This will result in a new PMC curve, PMC 2 , which is identical to the SMC curve. As a result, the tax effectively internalizes the externality and leads to the socially optimal outcome (point B, quantity Q 2 ). The government per unit tax on steel production acts in the same way as if the fishermen owned the river. This type of corrective taxation is often called “Pigouvian taxation,” after the economist A.C.

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  Environmental and Natural Resources Economics

  Theory, Policy, and the Sustainable Society

  • Steven Hackett, Sahan T. M. Dissanayake(Authors)
  • 2014(Publication Date)
  • Routledge

    (Publisher)

  Chapter 7 .

  Summary

  • Positive externalities are unpaid-for benefits to society generated as a by-product of production and exchange. When there are important positive externalities, market demand based on the private benefits of buyers understates the full social benefits of the good or service generating the external benefit. Consequently, too little of the good or service generating the positive externality is produced in otherwise well-functioning competitive markets. Subsidies represent a form of policy intervention that can enhance market efficiency by internalizing the positive externality. Positive externalities can also affect the supply curve, such as when there are knowledge spillover externalities.
  • While the legal system is designed to protect property, open-access and public trust resources were not traditionally protected under common law from pollution harms and thus remain subject to degradation. The legal system does not function perfectly, of course, and so pollution harms to people, their homes, and other valuable objects that are property do regularly occur. One problem is in determining the source of the pollution when there may be very large numbers of emitters, as is the case with automobile exhaust.
  • Negative externalities are uncompensated damage costs borne by members of society. These negative externalities are generated as a by-product of production and exchange. Profit-maximizing firms have an incentive to transform private costs into negative externalities (external costs) in the absence of regulation or reputation effects. When there are important negative externalities, market supply based on private costs to sellers is too large, leading to too much of the good or service generating the negative externalities being produced in otherwise well-functioning competitive markets. Pigouvian taxes represent a form of policy intervention that can enhance market efficiency.

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  Principles of Cost-Benefit Analysis for Developing Countries

  • Caroline L. Dinwiddy, Francis J. Teal(Authors)
  • 1996(Publication Date)
  • Cambridge University Press

    (Publisher)

  Negative externalities arise from various types of pollution: air pollution from smoking factory chimneys, water pollution from industrial effluents and noise pollution from consumption or production activities all have social costs which are typically not picked up by the price mechanism. There are abundant examples of such negative externalities in Third World countries; for instance, pollutants in the Delhi atmosphere have increased over the last ten years from 100 tonnes per day to 1990 tonnes per day, and are now reported to be a serious source of respiratory problems. 1 The welfare costs of externalities arise because potentially beneficial opportunities for trade fail to be exploited by private sector producers or consumers. These welfare losses can be analysed in terms of the three Paretian efficiency conditions discussed in chapter 4. With externalities, the signalling system provided by the price mechanism is absent and (in terms of figures 4.1 and 4.2) consumers and producers may fail to reach their respective contract curves. Smoking or playing loud music late at night are obvious examples of consumption activities which may have adverse effects on the utility of others. A famous example of a beneficial production externality that has been empirically investigated (see Cheung, 1973) is the mutual interaction between beekeeping and fruit production: the nectar from the fruit orchards nourishes the bees and the bees' activities pollinate the fruit trees. In cases of this kind there are potential Paretian improve- ments to be made - at least one consumer/producer could be made better off without others being made worse off. Similarly, in exchanges between producers and consumers, the existence of externalities leads to welfare losses if either producers or consumers face incorrect sets of relative prices. This idea was first presented in chapter 1 where, on pp.

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  Classic Papers in Natural Resource Economics

  • C. Gopalakrishnan(Author)
  • 2000(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  The legal position has also been modi- fied by statutory enactments. 53 Williams, op. cit. supra n. 49 at 242, 258. 54 Boulston v. Hardy, Cro. Eliz., 547, 548, 77 Eng. Rep. 216. 55 Williams, op. cit. supra n. 49 at 243. 56 58 Sol. J. 612 (1913–1914). 57 Williams, op. cit. supra n. 49 at 259. 58 Pigou, op. cit. supra n. 35 at 185. 59 Williams, op. cit. supra n. 49 at 244–47. 60 Pigou, op. cit. supra n. 35 at 192. 61 Id. 174–75. 62 Id. 177–83. 63 Id. 175–77. 64 Id. 192–4, 381 and Public Finance 94–100 (3d ed. 1947). The Problem of Social Cost 137 6 Externality James M. Buchanan and William C. Stubblebine Externality has been, and is, central to the neo-classical critique of market organisation. In its various forms – external economies and dis- economies, divergencies between marginal social and marginal private cost or product, spillover and neighbourhood effects, collective or public goods – externality dominates theoretical welfare economics, and, in one sense, the theory of economic policy generally. Despite this importance and emphasis, rigorous definitions of the concept itself are not readily available in the literature. As Scitovosky has noted, “defini- tions of external economies are few and unsatisfactory”. 1 The following seems typical: External effects exist in consumption whenever the shape or posi- tion of a man’s indifference curve depends on the consumption of other men. [External effects] are present whenever a firm’s production func- tion depends in some way on the amounts of the inputs or outputs of another firm. 2 It seems clear that operational and usable definitions are required. In this paper, we propose to clarify the notion of externality by defin- ing it rigorously and precisely. When this is done, several important, and often overlooked, conceptual distinctions follow more or less auto- matically.

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  A Course in Public Economics

  • John Leach(Author)
  • 2003(Publication Date)
  • Cambridge University Press

    (Publisher)

  Taxes and Subsidies The government could use taxes to deter activities that have negative externalities, and subsidies to encourage activities that have positive externalities. The tax deductibility of educational expenses is one example of the latter. Taxes on cigarettes and gasoline are examples of the former, although governments imposing these taxes are probably more interested in generating revenue than in controlling externalities. Taxes that control externalities are called Pigouvian taxes, after the economist Pigou who first suggested them. Consider the case of a firm which generates a negative exter-nality when it produces goods, and which has the relevant property rights (see Figure 6.2). The government imposes a tax on each unit of output produced by the firm. The tax is set equal to MD ∗ , marginal damage evaluated at the optimal level of output q ∗ . This new tax becomes part of the firm’s private marginal cost, so the P MC curve is shifted upwards by the amount MD ∗ . (The new P MC curve is labelled P MC in Figure 6.2.) The tax does not change social marginal costs because it is simply a transfer from one part of society, the firm, to another part of society, the government. The firm will maximize its profits by choosing the output at which P MC is equal to P MB . That is, the firm will choose the output level q ∗ . This tax forces the firm to “internalize” the damage done to others, that is, to act as if the external costs are borne by the firm itself. In the presence of the tax, the firm’s self-interested behaviour leads to the socially optimal outcome. The tax is a substitute for appropriate compensation. When an agent generates a negative externality, it is important that he pay compensation, because the necessity of doing so induces him to modify his behaviour. The tax forces him to recognize the Externalities and Negotiation 112 costs that he imposes on others, causing him to modify his behaviour in the same way.

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  Microeconomics

  Theory and Applications

  • Edgar K. Browning, Mark A. Zupan(Authors)
  • 2019(Publication Date)
  • Wiley

    (Publisher)

  In general, external costs should not be totally eliminated even though those who are harmed might like to see them reduced to zero. Instead, the gain from reduced pollution to people downstream must be weighed against the cost to consumers of reduced output. In this example we assumed that each unit of output is invariably associated with a certain amount of pollution. In the more general case the amount of pollution per unit of output is variable. Automobiles, for example, can produce various amounts of emissions. When this situation is the relevant case, as it usually is, the tax should be levied on pollution itself, not on the product. Then, as discussed in Chapter 8, firms have an incentive to curtail pollution— the external cost—in the least costly manner. Traffic Externalities: Their Causes and Some Potential Cures 3 While an individual motorist’s decision to drive at rush hour may cost only a few extra minutes of commuting time, the external congestion costs imposed by such motorists as a group can add up to millions of dollars per year in a major urban area. For example, an average driver in the Wash- ington, D.C. area spends 82 hours a year stuck in traffic, at a cost of over $1,800 per person in wasted time and gas. Across 471 urban areas in the United States, the average driver spends 42 hours stuck in traffic per year. The total cost in terms of gasoline and reduced productivity is esti- mated to be nearly $200 billion as of 2019. Beyond congestion costs, rush-hour commuters pay for only a fraction of what they impose on the community APPLICATION 20.3 3 This application is based on “In Singapore Driving a Car Is Easy but Owning a Car Isn’t,” Los Angeles Times, August 17, 1991, pp. A1 and A14; https://www.mikogo.com/2015/09/30/us-traffic-conges- tions; and https://mobility.tamu.edu/um. • Externalities 519 at large in terms of road construction and pollution costs.

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  Intermediate Microeconomics

  A Tool-Building Approach

  • Samiran Banerjee(Author)
  • 2021(Publication Date)
  • Routledge

    (Publisher)

  Chapter 14 Externalities An externality is the ac com pa ny ing im pact (whether pos i tive or neg a tive) of one agent’s con sump tion or pro duc tion ac tiv ity on the util ity or tech nol ogy of an other, where this impact is independent of markets or prices. A global example that jumps out at us from the Covid-19 pandemic is a person who has been infected by the SARS-CoV-2 virus but is asymptomatic. They can infect many others by riding public transport, for example, causing serious illness or death among the elderly, a negative externality. When a person gets a flu shot, they not only reduce their own chances of catching the flu, but also reduce the likelihood of transmitting the flu virus to others, a positive exter-nality. A confectioner’s machinery in 1879 England making it difficult for a cardiologist next door to listen to the heartbeat of his patients is an exam-ple of a negative production externality. A positive production externality is conferred by a bee-keeper located next to an apple orchard whose bees, by pollinating more flowers, increases their neighbor’s apple production. Because externalities are external to the workings of markets, the prices at which trades occur do not reflect their additional costs (in the case of neg-ative externalities) or benefits (in the case of positive externalities). Con-sequently, the First Welfare Theorem typically fails, i.e., in the presence of ex ter nal i ties, the Wal ras al lo ca tion is gen er ally no longer Pareto ef fi cient. We begin by illustrating this inefficiency and then consider three “solutions” that have been suggested to mitigate these problems and that have influenced government policy towards externalities. 262

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  Economics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  C H E C K P O I N T How specifically has the federal government regulated air, water, and land pollution? 17-4 Positive Externalities To this point, we have considered only negative externalities. But externalities are some- times positive, or beneficial. Positive externalities occur when consumption or produc- tion benefits other consumers or other firms. For example, people who get inoculated against a contagious disease reduce their own likelihood of contracting the disease (the personal benefit), but they also reduce the risk of transmitting the disease to others Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 17 Externalities and the Environment 393 (the external benefit). Parents who don’t get their children vaccinated risk triggering an epidemic, so the vaccination decision is not simply a private matter. For example, the Centers for Disease Control and Prevention recently reported an outbreak of measles in 17 states because some children were not vaccinated. 24 Another positive externality results from education. Society as a whole receives exter- nal benefits from education because those with more education become better citizens, can read road signs, are better able to support themselves and their families, and are less likely to require public assistance or to resort to violent crime for income. Researchers found that more schooling significantly reduces the probability of incarceration. 25 Also, the higher the minimum dropout age for school, the lower the arrest rate for property and violent crimes among 16-to-18-year-olds.

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