Economics
Public Solutions to Externalities
Public solutions to externalities refer to government interventions aimed at addressing the impact of externalities, which are the spillover effects of economic activities on third parties. These solutions can include implementing taxes or subsidies to internalize external costs or benefits, establishing regulations and standards, and creating tradable permits systems. The goal is to align private incentives with social welfare and promote efficient resource allocation.
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9 Key excerpts on "Public Solutions to Externalities"
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 - PDF- Michael Albert, Robin Hahnel(Authors)
- 2017(Publication Date)
- Princeton University Press(Publisher)
236 The Prevalence of Externalities and Public Goods 2. There is no qualitative difference between public goods and exter- nalities and no reason to treat them differently at a theoretical level. Public goods or bads are simply externalities whose effects are more pervasive than what convention has chosen to call an externality. Externalities are simply public goods or bads whose effects are too circumscribed to merit the label public. 3. The primary intentions of the economic actor whose decision generates external effects for others and the private or public status of that actor, are of no theoretical consequence as far as social efficiency is concerned. 4. The issue is not the characteristics of goods but the characteristics of markets, since it is the market/propertyrightsystem that establishes who gets to make what decisions. How is it that "traditional solutions" that involve a government with coercive powers might improve matters? And why have economists con- cluded that while "traditional solutions" might improve upon market allocation and voluntary association, they are all, to some extent, inevitably flawed? Here we will uncover a very peculiar lack of rigor in the analysis by traditional welfare theorists. Suppose we substitute a government for the market-property-right system of allocating resources in all cases where external effects exist and instruct the government to do so in a socially efficient manner. The goverment must decide two things: how much of each activity that generates effects external to the market decision-making process should occur, and how much to assess each citizen to defray whatever costs may arise from implementing its first decision. In language more familiar to students of public finance, the goverment must make (1) a decision about expenditures—how much to spend on the provision of different public goods, and (2) a decision about taxation—how to collect the revenues necessary to cover the expenditures.
eBook - PDFPublic Finance
A Normative Theory
- Richard W. Tresch(Author)
- 2002(Publication Date)
- Academic Press(Publisher)
An activity by a set of economic agents enters ``alters'') the utility functions of other consumers or the production functions of other producers not directly involved with the activity. 2. The gains and losses from these e V ects are not properly re X ected in the competitive market system. This second condition is redundant in most cases, 146 POLICY-RELEVANT EXTERNALITIES since externalities satisfying the W rst condition are almost never accounted for properly by the competitive market system. Given the existence of externalities with these two properties, a perfectly competitive market economy no longer generates a pareto-optimal allocation of resources. Government intervention may be required to keep society on its W rst-best utility-possibilities frontier. The only other possibility is private bargaining among the a V ected parties, which can be pareto optimal under certain conditions. The Terminology of Externalities Public sector economists struggled for years trying to pinpoint what kinds of third-party e V ects required government intervention. The puzzle was W nally resolved in 1931 when Jacob Viner distinguished between pecuniary and technological externalities, terminology that remains in use today. 1 Pecuniary externalities refer to the market price e V ects illustrated by the W rst situation, those resulting directly from competitive market adjustments. They do not require public intervention to maintain pareto optimality. Technological externalities refer to third-party e V ects that satisfy the two conditions de-scribed above. These are the policy-relevant externalities. The externality literature is W lled with jargon to distinguish among the many di V erent kinds of externalities. For instance, public sector economists distinguish between external economies and diseconomies : The former term refers to bene W cial third-party e V ects, the latter to harmful third-party e V ects.
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- 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.
eBook - PDF- Richard W Tresch(Author)
- 2021(Publication Date)
- Bloomsbury Academic(Publisher)
And it is in everyone’s mutual interest to develop a market for the rights. The essence of an uncorrected externality, or any allo-cational efficiency problem, is that it drives the economy below its utility possibilities frontier, such as at point A in Figure 7.2 . All points to the north, east, and northeast of A on the line segment BC are Pareto superior to A: They make one person better off without making anyone else worse off, or both people better off. Rational individuals should try to move from A to some point on the line segment BC and exploit these potential gains however they can, and the market exchange of pollution rights is one way to do it. Nonetheless, establishing a market for pollution rights is likely to encounter severe practical difficulties, especially when a large number of people are affected by an exter-nality as is often the case with air pollution. The transactions costs alone of bringing everyone together would be formidable. Also, people would have an incentive to free ride on the goodwill of other people if firms owned the pollution rights. (The same incentive to free ride would apply to the factory owners if the people owned the pollu-tion rights.) The problem is that each person affected by pollution has to consume the same aggregate amount of pollution, unlike a normal market in which people can consume whatever quantities of a good or service that they want. These difficulties lead most economists to conclude that the Coase Theorem is inapplicable when externalities are widespread, which are precisely the kinds of externalities that governments become involved in. A Pigovian tax (or equivalent government policies – see below) is required to correct for externalities in these instances.
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.
- Roberto Serrano, Allan M. Feldman(Authors)
- 2018(Publication Date)
- Cambridge University Press(Publisher)
In this chapter, we will look at market failures created by public goods. A public good is a good that is non-exclusive in use . That is, if it is there and available for use by one consumer, then it is there and available for use by all consumers. In a sense, these are goods that create super-externalities. For example, a judicial system is a public good. If the laws, courts, and police are in place to protect person i , they are there to protect person j as well. (Obviously, a public good may be valued differently by the different people; i might be a shopper, happy to have the police around to protect her, and j might be a shop-lifter!) A non-public good is sometimes called a private good . A pair of socks is a private good. If i is wearing a pair of socks, then j is not wearing that pair of socks. But if i has that judicial system, then j has it also. We know that markets should provide efficient or Pareto optimal quantities of things like socks. However, as we will see, markets provide inefficient quantities of public goods . The presence of public goods creates another important type of market failure. In this chapter, we will first provide some examples of public goods. Next, we will describe a simple model of public goods. The model makes it clear why private market provision of a public good is inefficient. That is, it makes clear why public goods result in market failure. Then we will turn to the Samuelson optimality condition , the condition that must hold for the quantity of a public good to be Pareto optimal or efficient. After that we will discuss the free rider problem – the problem of consumer i taking advantage of consumer j ’s decision to produce some of the public good, which, since it is available for i to use, causes i to take a free ride on j ’s good citizenship. In the same section, we will discuss provision of the public good through voluntary contributions.
eBook - PDFIntermediate Microeconomics
A Tool-Building Approach
- Samiran Banerjee(Author)
- 2021(Publication Date)
- Routledge(Publisher)
But how can the separate firms achieve this Pareto superior situation without merging? One way would be for firm F to convince firm A to re-duce its acid production from 18 units to 8 with the assurance that firm F would make up the remainder of A ’s profit and guarantee that firm A con-tinues to make at least $324. Indeed, it is possible for both firms to be better off relative to the free market profit levels through such bilateral negotiation. 14.2 Three “Solutions” There are several ways to mitigate the inefficiencies that arise from external-ities, all of them imperfect in some regard. The most crude of these is di-rect regulation which involves the direct intervention by some governmen-tal body (for example, the US Environmental Protection Agency). However, of particular interest are three partial solutions (hence the quotes in the title of this section) associated with the names of Arthur Pigou, Kenneth Arrow, and Ronald Coase which have been extremely influential in formulating eco-nomic policy when externalities are present. The nature of the intervention differs in the three cases and these are considered in greater detail below. 14.2.1 Pigou: Taxes or subsidies Pigou’s idea is a step removed from direct regulation and uses the notion that appropriately taxing an entity that is imposing a negative externality or 2 To look at Pareto efficiency more rigorously in this context, we would need a general equilibrium model with at least one consumer and two producers, which is beyond the scope of this text. Externalities 267 subsidizing one whose economic activity is associated with positive exter-nalities can mitigate the problem. To see how this may work in the context of the production externality from section 14.1.2, suppose a tax of t per unit is imposed on acid production, so firm A ’s profit function is then λ A ( a ) = 36 a − a 2 − ta . Then the derivative with respect to a is 36 − 2 a − t , and when a ≥ = 8, this derivative equals zero if t = 20.
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