C.
EXTERNALITIES: THE PROBLEM AND SOLUTIONS, TAXES VERSUS REGULATION,
PROPERTY RIGHTS, THE COASE THEOREM.
EXTERNALITIES: PROBLEMS AND SOLUTIONS
What Is an Externality?
An externality is a cost or benefit that is caused by one party but financially incurred or
received by another. Externalities can be negative or positive. A negative externality is
the indirect imposition of a cost by one party onto another. A positive externality, on the
other hand, is when one party receives an indirect benefit as a result of actions taken
by another.
Externalities can stem from either the production or consumption of a good or service.
The costs and benefits can be both private—to an individual or an organization—or
social, meaning it can affect society as a whole.
Types of Externalities
Externalities can be broken into two different categories. First, externalities can be
measured as good or bad as the side effects may enhance or be detrimental to an
external party. These are referred to as positive or negative externalities. Second,
externalities can be defined by how they are created. Most often, these are defined as
a production or consumption externality.
Negative Externalities
Most externalities are negative. Pollution is a well-known negative externality. A
corporation may decide to cut costs and increase profits by implementing new
operations that are more harmful to the environment. The corporation realizes costs in
the form of expanding operations but also generates returns that are higher than the
costs.
However, the externality also increases the aggregate cost to the economy and society
making it a negative externality. Externalities are negative when the social costs
outweigh the private costs.
Positive Externalities
Some externalities are positive. Positive externalities occur when there is a positive
gain on both the private level and social level. Research and development (R&D)
conducted by a company can be a positive externality. R&D increases the private profits
of a company but also has the added benefit of increasing the general level of
knowledge within a society.
Similarly, the emphasis on education is also a positive externality. Investment in
education leads to a smarter and more intelligent workforce. Companies benefit from
hiring employees who are educated because they are knowledgeable. This benefits
employers because a better-educated workforce requires less investment in employee
training and development costs.
Production Externalities
A production externality is an instance where an industrial operation has a side effect.
This is often the type of externality used as example, as it is easy to envision an
environmental catastrophe caused by improperly stored chemicals by a chemical
company. Because of how the company produced its goods or protected its waste, an
externality occurred.
Consumption Externalities
Externalities may also occur based on when or how a consumer base utilizes resources.
Consider the example of how you get to work. Those who choose to drive are creating a
pollution externality by driving their own car. Those who choose to take public transit or
walk are not causing the same externality. Instead of a side effect occurring because
something is being produced, an externality is caused because of an item being
consumed.
Externality Solutions
There are solutions that exist to overcome the negative effects of externalities. These
can include those from both the public and private sectors.
Taxes
Taxes are one solution to overcoming externalities. To help reduce the negative effects
of certain externalities such as pollution, governments can impose a tax on the goods
causing the externalities. The tax, called a Pigovian tax—named after economist Arthur
C. Pigou—is considered to be equal to the value of the negative externality.
This tax is meant to discourage activities that impose a net cost to an unrelated third
party. That means that the imposition of this type of tax will reduce the market outcome
of the externality to an amount that is considered efficient.
Subsidies
Subsidies can also overcome negative externalities by encouraging the consumption of
a positive externality. One example would be to subsidize orchards that plant fruit trees
to provide positive externalities to beekeepers.
This nudge has the potential to influence behavioral economics, as additional
incentives one way or another way dictate the choices that are made. The subsidy is
often placed on an opposing item to detract from a specific activity as well. For
example, government incentives to upgrade to more energy-efficient renovations
subtly discourages consumers against options with more externalities.
Other Government Regulation
Governments can also implement regulations to offset the effects of externalities.
Regulation is considered the most common solution. The public often turns to
governments to pass and enact legislation and regulation to curb the negative effects
of externalities. Several examples include environmental regulations or health-related
legislation.
The primary issue with government regulation of externalities is the need for consistent
and reliable information to track the externality is being managed or overcome.
Consider regulation against pollution. The government put forth resources to ensure
that the legislation put in place is actually being followed, including holding bad actors
accountable for not properly addressing their exter.
What Is the Most Common Type of Externality?
Most externalities are negative, as the production process often entails byproducts,
waste, and other consequential outcomes that do not have further benefits. This may
be pollution, garbage, or negative implications for worker health. Many externalities are
also related to the environment, as the mechanical nature of manufacturing and
product distribution has many detrimental impacts on the environment.
EXTERNALITIES: PROBLEMS AND SOLUTIONS
• Market failure: A problem that violates one of the assumptions of the 1st welfare
theorem and causes the market economy to deliver an outcomes that does not
maximize efficiency.
• Externality: Externality arise whenever the actions of one economic agent make
another economic agent worse or better off, yet the first agent neithr bears the
costs nor receives the benefits of doing so:
Example: A steel plant that pollutes a river used for recreation exeternalities are one
example of market failure.
IMPORTANCE FOR MARKET FAILURE.
1)Not excludable and unpriced.
2)It effects not only with the organization but also to their society.
3)It mainly arises from the production of good and services.
TAX AND REGULATION
TAX.
Tax is a compulsory payments by the citizens to the government to meet the public
expenditure. It is legally imposed by the government on the taxpayer and in no case,
taxpayer can deny to pay taxes to the government. The taxpayer also cannot expect only
service or benefit from the government in relearn of the tax payment, that is nom quid-
pro-quo.
ACCORDING TO ANATOL MURAD,”A tax is a compulsory payments made by a person are
firm to a government without reference to any benefit that payer may derive from the
government.”
Taxation and Regulation are both tools used by governments influence economic
behavior and manage public resources, but they work in different ways:
1. Taxes: These are financial charges imposed on individual and business
needs by the government. Taxes can serve various purposes, including raising revenue
for public services, redistributing wealth, and incentivizing or disincentivizing certain
behaviors. For example, a carbon tax is designed to reduce greenhouse gas emissions
by making polluting activities more expensive.
2. Regulation: This involves rules and guidelines established by authorities
to control or direct economic activity and behavior. Regulations can set standards for
safety , environmental protection, and business practices. For instance, regulations
may limit the amount of pollutants a factory can emit or require companies to certain
safety standards.
IN SUMMERY, while taxes influence behavior through financial cost, regulations
directly control or restrict certain activities to achieve desired outcomes. Both are used
to achieve policy goals, but their mechanisms and impacts can differ significantly.
Different Types of Taxation:
Income tax: Governments impose income taxes on financial income generated by all
entities within their jurisdiction, including individuals and businesses.
Corporate tax: This type of tax is imposed on the profit of a business.
Capital gains: A tax on capital gains is imposed on any capital gains or profits made by
people or businesses from the sale of certain assets including stocks, bonds, or real
estate.
Property tax: A property tax is asses by a local government and paid for by the owner of
a property. This tax is calculated based on property and land values.
Inheritance: A type of tax levied on individuals who inherit the estate of a deceased
person.
Sales tax: A consumption tax imposed by a government on the sale of goods and
services. This can take the form of a value-added tax (VAT), a goods and services tax
(GST), a state or provincial sales tax, or an excise tax.
PROPERTY RIGHTS
• WHAT ARE PROPERTY RIGHTS?
Ans: Property rights explain the legal and intellectual ownership of assets and
resources and one can make use of the same. These assets and resources can be both
intangible or tangible in nature, and the owner can be government, individuals, and
business.
Property rights give the owner or right holder the ability to do with the property what
they choose. That includes holding on to it, selling or renting it out for profit, or
transferring it to another party, property rights define the theoretical and legal
ownership for resources can be both tangible or intangible and that can be owned by
individuals, business, and governments.
UNDERSTANDING PROPERTY RIGHTS.
• Physical resources such as houses, cars, books, and cellphones.
• Non-human creatures like dogs, cats, horses, or birds.
• Intellectual property such as inventions, ideas, or words.
WHAT IS COMMON PROPERTY.
Ownership of common property is shared by more than one individual and/ or
institution. Rights to its disposition and other factors are divided among the group. No
single individual or entity has absolute control. This is commonly the case when you
purchase a condominium or in a development with a homeowners’ association or if you
own property with another individual as tenants in common.
WHAT IS OWN ACCESS PROPERTY;.
No individual, business, or even a government entity can claim property rights to open-
access property. it’s not owned by anyone or nothing can claim that the Atlantic ocean
belongs to them. Anyone can fish there, dive there, or build a floating home on its
surface.
PRIVATE PROPERTY RIGHTS.
Private property rights are one of the pillars of capitalist economics as well as many
legal systems and moral philosophies. Individuals need the ability to exclude others
from the uses and benefits of their property within a private property rights regime.
All privately owned resources are rivalries. Only a single user may possess the title and
legal claim to the property. Private property owners also have exclusive right to use and
benefit from the services or products. Private property owners may exchange the
resource voluntarily.
ANOTHER ANSWER.
Laws specifying the theoretical and legal ownership of resources and how they can be
used.
• THE COASE THEOREM
COASE THEOREM.
A theory that bargaining between individuals or groups individuals or groups over
property rights will lead to an optimal and efficient outcome,
WHAT IS COASE THEOREM?
The coase theorem is legal and economic theory developed by economist Ronald
Coase regarding property rights, which states that where there are complete
competitive markets with no transaction costs and an efficient set in inputs and
outputs, an optimal decision will be selected. It basically asserts that bargaining
between individuals or groups related to property rights will lead to an optimal and
efficient outcome, no matter what that outcome is.
UNDERSTANDING COASE THEOREM.
The coase theorem is applied when there are conflicting property rights. The coase
theorem states that under ideal economic of property rights, the involved parties can
bargain or negotiate terms that will accurately reflect the full costs and underlying
values of the property rights at issue, resulting in the most efficient outcome. For this
to occur, the conditions conventionally assumed in the analysis of efficient,
competitive markets must be in place, particularly the absence of transaction costs.
The information must be free, perfect, and symmetrical.
The coase theorem has been widely viewed as an argument against the legislative or
regulatory intervention of conflicts over property rights and privately negotiated
settlements thereof. It was originally developed by Ronald Coase when considering the
regulation of radio frequencies. He posited that regulating frequencies was no required
because stations with the most to gain by broadcasting on particular frequency had an
incentive to pay other broadcasters not to interfere.
EXAMPLE OF COASE THEOREM.
For example, if a business that produces machines in factory is subject to noise
complaint initiated by neighboring households who can hear the loud noises of
machines being made, the coase theorem would lead to two possible settlements.
WHO WAS RONALD COASE.
Ronald H. Coase was a British economist contributions to the fields to transaction cost
economics, law and economics, and new institutional economics. He was awarded the
Nobel Memorial Prize in economics science in 1991 for his elucidation of the role of
transection costs, property rights, and economic institutions in the structure and
functioning of the economy. He died in 2013 at age 102 in Chicago, Illinois, where he
taught economics at the university of Chicago law school.
THE BOTTOM LINE.
The coase theorem is a legal and economics theory regarding property rights. It states
that where there are complete competitive markets with no transection costs and
efficient set of input and outputs, an optimal decision will be selected, it was developed
by economist Ronald Coase.
