Other solutions to negative externalites

Provison of info

• When there is asymmetric information, the govemment provides information to allow people to make informed decisions. They may also force companies to provide information.

• Advantages:

  • . This helps consumers to act rationally, which allows the market to work proporly.

    . It is best if the government uses this alongside other policies. For example, il can make demand more elastic in the long run and so help indirect taxes to become more

    effective at reducing output

• Disadvantages:

  . This can be expensive for the government to do, incurring an opportunity cost.

  . The govemment themselves may not always have all the information, so it may be

  difficult to inform consumers.

  . Pensumers may not listen to the information provided due to irrational behaviour.

Regulation

• Governments are able to impose laws and caps to ensure that levels are set where MSB=MSC or to ensure that companies provide full information on products. The government can also introduce regulatory bodies such as OFCOM for communications and OFGEN for energy. These ensure firms follow regulation and do not exploit their customers or take advantage of market position.

Advantages:

. This can ensure consideration of externalities, prevent exploitation of consumers and

keep consumers fully informed. This will help to overcome market failure and

maximise social welfare.

isadvantages:

. Laws may be expensive for the government to monitor, incurring an opportunity cost.

. They don't take into account the different costs of following the laws for different

companies. Compared with tradable pollution permits, regulation is a less efficient

method of reducing pollution.

. The govemment can suffer from regulatory capture (looked at in Theme 3).

. Firms may pass on costs to the consumer in the form of higher prices.

. Excessive regulation may reduce competition in a market and efficiency, by

increasing bureaucracy and reducing innovation.