Economics
Private Solutions to Externalities
Private solutions to externalities refer to the ways in which individuals and firms can address the external costs or benefits of their actions without government intervention. These solutions include bargaining, contracts, and the internalization of externalities through property rights. By internalizing the external costs or benefits, private actors can align their self-interest with the social interest, leading to more efficient outcomes.
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10 Key excerpts on "Private Solutions to Externalities"
eBook - PDFCommon-Property Arrangements and Scarce Resources
Water in the American West
- Edward M. Barbanell(Author)
- 2001(Publication Date)
- Praeger(Publisher)
The strict dominance of free-riding, or foul-dealing, be- havior ensures an inferior outcome; everyone overgrazes. EXTERNALITIES AND PRIVATE OWNERSHIP Within neoclassical economics, the general solution to free-rider problems involves transforming the social costs of an individual’s ac- tion into private costs via the establishment of enforceable property rights. 46 Whether it be by establishing a private property regime, or by establishing some other form of ownership, the idea is that those who produce externalities should be forced to take into account all the costs of their actions. The goal is to make individual deci- sion-making units responsible for all the effects of their actions: if the benefits of an action outweigh all the costs, then the activity (e.g., overgrazing, emitting chemicals, or increasing salinity) will occur; if Economics and Property Rights 123 not, then individuals will refrain from such activities. If enforceable rights and duties can be established that correspond to these bene- fits and costs, then what has happened, in effect, is that externality has become internalized. As Demsetz writes, “The main allocative function of property rights is the internalization of beneficial and harmful effects.” 47 Given the incentive structure all players are expected to follow in Prisoner’s Dilemmas or limited-user open-access situations, the im- plication to most economists has been that individuals should be given extensive private property rights, or private ownership, over the resource in question. In the most general sense, rights and their opposites, duties, specify how individuals may be benefited and harmed.
eBook - PDF- 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.
eBook - ePubEnvironmental 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.
eBook - PDFEnvironmental Economics
Theory and Policy
- Alfred Endres, Iain L. Fraser(Authors)
- 2010(Publication Date)
- Cambridge University Press(Publisher)
However, allowing such a right would go beyond the framework of the “law of the jungle” as an allocation mechanism. Where it is claimed in the text that under this law the utilization plans of the producers of the externalities would prevail, we are ignoring the possibility that those damaged prevent the emissions by force. 3 Cf. chapter A in part two. 4 Cf. section B.III in part three. The Internalization of Externalities as a Central Theme of Environmental Policy 3 Many economists are particularly fascinated by comparing the actual result reached by a particular allocation mechanism with a “socially optimal” result. Of course, it is necessary for this undertaking to develop a criterion of social optimality. If an analysis of the market mechanism finds that the market outcome (“equilibrium”) departs from the optimum, this gives the economist occasion to ponder possible correction mechanisms. 5 We show in detail that the existence of environmental problems (in economic terminology, “externalities”) establishes a divergence between market equilibrium and optimum. The “internalization of externalities” treated in part two of this book is nothing but an attempt to make economic policy corrections to the market mechanism with the aim of bringing equilibrium and optimum together. Of course, the demand that politics should bring about an optimum position is – in the sphere of environmental policy as in any other sphere – for various reasons too ambitious. Nonetheless, it is worthwhile to operationalize the concept of optimality and discover structural causes of market mechanism failures by comparing the market equilibrium with the optimum. Even if, in reality, the optimum will perhaps never be reached, we might still provide guidance to environmental policy, which all too often has its view of what direction to take confused (comprehensible as this may be) by the undergrowth of everyday problems.
eBook - PDF- Michael Albert, Robin Hahnel(Authors)
- 2017(Publication Date)
- Princeton University Press(Publisher)
Hunt complained that traditional welfare theory "simply takes the externalities, for which property rights and markets are to be established, as somehow metaphysically given and fixed. In ignoring the relational aspects of social life their theory ignores the fact that individuals can create externalities almost at will." 52 Hunt meant that individuals with different preferences over the state of the world they must share can create negative externalities for one another (or withold positive externalities) for bargaining purposes "almost at will." In this sense those externalities are not "given and fixed." But in a world of exogenous preferences the opportunity costs (to me) of the negative externalities I can choose to cause others is fixed. However, in a world of endogenous preferences they are not. People can expand on their effective ability to do each other harm by "rationally" developing their preferences in contradic- tory directions. Of course, in this case the "invisible foot" comes down with an even heavier thud as people who "seek only their private gain, and neither intend to promote the public misery nor know how much they promote it" nonetheless make it increasingly impossible for everyone to be satisfied in the one world in which they must all live. 233 MARKETS 7.7.2 The Inadequacy ofTraditional Solutions In chapter 3, we briefly summarized the traditional view of the source of the "problem" posed by public goods and externalities, as well as the consensus that prevailed prior to the advent of incentive-compatible mech- anisms regarding the inadequacy of all "solutions." We quoted Richard Musgrave to the effect that just as markets and voluntary associations were demonstrably inefficient, so too were all "solutions" that had been proposed whether they were of the "benefit" approach, the "ability to pay" approach, or any of a variety of voting systems.
eBook - PDFProduction, Growth, and the Environment
An Economic Approach
- William L. Weber(Author)
- 2014(Publication Date)
- CRC Press(Publisher)
In addition, a high demand for fish from nearby cities changed local conditions and made it profitable for fishers to go for the quick profit at the expense of a sustainable fishery. Finally, as group size increases, efforts at self-monitoring become more difficult as the free-rider problem becomes greater in large groups. 172 Production, Growth, and the Environment 8.5 Internalizing Externalities through Taxes and Sub-sidies Various policies can be tried to move the economy in the right direction when externalities exist. These alternatives include taxes and subsidies, defining property rights, imposing quantity controls, negotiation, and appeal to the social contract. Taxes can be imposed on goods that generate a negative ex-ternality and subsidies can be given to producers or consumers who generate positive externalities. Private property rights such as marketable pollution permits are used in the electric power industry to control pollution and indi-vidual transferrable quotas are used in fisheries to prevent overfishing. Some-times quantity controls are imposed. If the production of a good or service is such that the marginal social cost is always greater than the marginal benefit an outright ban on production is efficient. The first policy option we consider is the use of taxes or subsidies to help control negative or positive externalities. In the case of a negative externality, imposing a tax equal to the marginal external cost of production gives the producer the incentive to cut production thereby reducing the external costs. In contrast, when a positive externality occurs a subsidy given to the consumer equal to the marginal external benefit encourages greater consumption. These kinds of taxes or subsidies help to internalize the externality and are referred to as Pigouvian taxes and subsidies after the economist A.C.
- Roberto Serrano, Allan M. Feldman(Authors)
- 2018(Publication Date)
- Cambridge University Press(Publisher)
What can be done about situations like this? A free-market zealot might say: “The government should do nothing. Never touch the market. Socialists, keep your hands off! The market knows what it is doing!” But as we have seen, the analysis suggests this is wrong. On the other hand, an environmental zealot might say: “The government should crack down on those polluting sons of b . . . s. Activities that create water pollution and mess up fish farms should be shut down.” But this would also be wrong, because the optimal amount of oil to refine (with accompanying pollution) is not 0. (And we are aware that in reality fish farms also pollute.) In the next section of this chapter, we will discuss solutions to the externality problem. 17.4 Classical Solutions to the Externality Problem: Pigou and Coase We have seen that market decisions about production may be non-optimal or ineffi-cient when there are external effects; that is, when one producer’s production decisions have direct effects on another producer’s costs. There are several possible solutions to externality generated market failures, which will be outlined here and in the next two sections. Pigouvian taxes and subsidies. The problem we saw in the last section came about because the oil refiner did not have to pay the external cost it imposed on the fish farmer. One possible solution is to tax the oil refiner. The tax would be collected by the government. Ideally, the tax would be tightly linked to the cost imposed by the oil refiner on the fish farmer. Such taxes were advocated in 1920 by the great English economist Arthur Pigou (1877–1959) in his book The Economics of Welfare . Therefore, we call them Pigouvian taxes . If an externality is positive instead of negative, efficiency might require that the government pay the firm creating the externality a subsidy, in order to increase its output of the good with the beneficial externality.
eBook - PDFWelfare Economics
Towards a More Complete Analysis
- Y. Ng(Author)
- 2003(Publication Date)
- Palgrave Macmillan(Publisher)
In particular a certain quota on the maximum permissible amount of externality could be specified. Economists are generally in favour of making quotas freely transferable. Thus if the government did not want a certain pollutant to exceed X units it could issue X units of quotas, which could either be distributed proportionally or, better still, sold to the polluters, who could later exchange them for money if their circumstances changed. Producers who could only reduce their pollution at a high cost would be motivated to pay for quotas, while those who could do so at a low cost would be motivated to reduce their pollution levels. Thus an overall reduction in the pollution level could be achieved at a lower cost to society as a whole (see for example Parish, 1972; Baumol and Oates, 1975; on solving the problem of siting unwanted facilities see Quah and Tan, 2002). When choosing between alternative methods of tackling the externality problem, it is necessary to consider not only their ability to achieve the Externality 153 desired result but also the costs (informational, administrative and so on) of their implementation. It is likely that different external effects will best be solved by different methods, including doing nothing. The various methods of tackling externalities discussed above are applic- able only to normal external effects. There is a special type of externality that is inherently not amenable to the usual solutions, even assuming there are no informational, administrative or transaction costs. This externality usually involves non-economic activities such as social interactions that change their character when taxes/subsidies and so on are introduced. For example if I received a subsidy for being friendly to my neighbours, they might regard my friendliness as bogus and I might reduce my contact with them to avoid being accused of being friendly only because of the subsidy.
eBook - PDF- John Leach(Author)
- 2003(Publication Date)
- Cambridge University Press(Publisher)
Two situations in which externalities are important, common property exploitation and co-ordinated behaviour, are examined in detail. 102 6 Externalities and Negotiation Every externality involves people or firms interacting in ways that don’t involve the market – perhaps they breathe the same air or drive on the same highways. However, not every non-market interaction results in an externality. An externality only arises when people or firms pursue their own interests so relentlessly that they fail to consider the effects that their actions have on others. An agent – that is, a person or firm – can be persuaded to recognize the interests of others by compensating him for his beneficial acts and forcing him to compensate others for his harmful acts. When this kind of compensation occurs, every agent will recognize the interests of other agents because doing so advances his own interests. Much of the economic study of externalities centers on the role of explicit monetary compensation in the control of externalities. Our discussion of this issue will proceed in three steps. First, we will examine the meaning of “appropriate compensation” and its impact upon market transactions. Second, we will consider some of the reasons why compensation might not occur. Lastly, we will consider the role of the government in controlling externalities in the absence of appropriate compensation. 6.1 NEGOTIATED COMPENSATION When one person’s actions affect another’s welfare, someone will be searching for a compromise. That person might be the initiator of the action, or the person whose welfare is affected by the action. One form of compromise is an agreement with two elements: a change in the extent of the initiator’s activities, and a cash transfer that compensates the person adversely affected by the change. Who pays whom is largely a matter of property rights.
eBook - PDF- 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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