corecting negative externalities in production

What does negative externalities in production essay questions commonly refer to

The environment

what type of good is the environment

A free good which has a marginal cost of zero

Marginal cost 0 means

If the marginal benefit is above 0 that will lead to the environment being used

How to correct negative externalities in production

Costs need to be internalised so that the marginal private costs of production incorporates the cost of environmental damage

When is there no externality in production

If MPC=MSC

What does government intervention do

Attempts to make the market face total social costs in production so that MSB=MSC

What does externalities in production lead to

Over allocation and a failure of the price mechanism (price does not incorporate all costs of production)

What will internalising the costs of production do

Increase production costs,supply curve shifts left, leads to social efficiency

What is a pigouvian tax

Is a tax imposed to correct negative externalities,reduce over consumption and is set equal to marginal external cost at socially optimal level of output

How does pigouvian tax work

internalises external costs of production, the tax levy will be equal to the value of the externality, therefore firms face the equivalent of the social cost of production eg pollution costs

Pigouvian tax diagram

Supply shifts left leads to an allocation of q2 and social efficiency will occur as all costs are internalised

Evaluations of Pigouvian tax

1.lack of information

2.inelastic demand

3.unintended consequences

4.political bias

5.free rider and international agreements

Evalution: lack of information

Government lack information so cannot be expected to know the value of the externalities. Eg what is the price of fresh air

Therefore information failure means that pigouvian tax cannot fully internalise the cost of externalities as the values are not. Cannot make PMC=SMC

Evalution: Inelastic demand

Pigouvian tax designed to increase the price of environmental damage

Inelastic demand means that the demand won’t be very responsive to a change in price eg. A tax on fossil fuel will have a limited effect on the demand for fossil fuel if there is an inelastic response

Evalution: unintended consequences

By increasing the price via tax imports will seem cheaper and there increase carbon footprints from the energy used in transport of imports

Moreover lower economically developed countries have more deregulated environmental regulations and so will lead to more harmful production processes

Evaluation: political bias

Government lack information and they are also incentivised not to tax domestic industries

Taxing domestic industries will increase cost of production lead to a decrease in RGDP,lower SOL, rise unemployment

Evalution: free rider and international agreements

Governments don’t want to tax there economy but would like other governments to tax their own economies.

Therefore an economy can free ride the benefits from other economies applying pigouvian taxes

Leads to no/few countries applying Pigouvian

As a result there needs to be an international agreement for Pigouvian taxes to be applied to remove the free rider problem

Regulation

Government rules and laws that control or influence the behaviour of firms and markets in order to protect consumers,workers and the environment

What can regulation be used for

To restrict supply shifting left from S to S1

Regulation evaluation

1.information failure

2regulatuor