Regulatory interventions with externalities

What is the purpose of gov interventions with externalities?

To internalise externalities, so the price of the transaction will cover the cost of the externality.

Examples of govt. interventions

1. Smoking bans in public places

2. Age restrictions on gambling/ tanning beds/ alcohol/ drugs

3. Limit on CO₂ emissions for new vehicles

4. Recycling directives for household appliances

5. Banning west wood for use in indoor burners

6. Fishing quotas to protect stocks from overfishing

Advantages of regulating activities with -ve externalities

- Act as a spur for business innovation to cut the level of carbon emissions

- More effective if demand is unresponsive to price changes

- They can be gradually toughened year by year, helping stimulate investment.

Costs of extra regulations on businesses

- High cost of enforcement/ administration of strict laws

- They can lead to unintended consequences (market failure)

- The cost of meeting regulations can discourage small businesses.

What are 3 negative externalities caused by chemicals and sewage leaked into rivers?

1. Health: risk of drinking polluted water leading to sickness, increased health costs

2. Nature: loss of biodiversity

3. Economic impact: wider cost to tourist businesses and impact on house prices

What are some interventions to curb river pollution?

1. Investment in new sewage infrastructure

2. Unlimited fines/ risk of prosecution

3. Pollution tax - internalises the externality

Diagram of this river pollution externality

Negative production externality

A carbon tax would shift the MPC leftward toward the MSC, internalising the externality and reducing the welfare loss.