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Externalities - Research Paper Example

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EXTERNALITIES Name Institution Date EXTERNALITIES Introduction Externality refers to the situation in which the action of one economic agent directly affects another agent either positively or negatively but the first agent neither bears the cost nor receives the benefits…
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Download file to see previous pages... They can also be referred to as the spill-over effects in the economy. Negative externalities results social costs to the society exceeding the private costs while positive externalities results in social benefits exceeding the private benefits. A case of negative externality can be illustrated by the graph shown below. Externalities and their solutions Air pollution is one of the major forms of negative externality. It arises from the burning of fossil fuels. Smoke from motor vehicles results to negative effects on the health of the road users leading to cancerous infections. The owners of the motor vehicles do not bear the cost of medical treatment to those affected. Smoke from cigarettes imposes a cost on the non-smokers who have to bear the cost of treating diseases due to smoke. This form of externality can be mitigated through the imposition of taxes commonly known as Pigovian tax which is usually set at a figure close to the cost of that externality. However this has a challenge in determining the actual amount of tax to be imposed (Papandreou, 1998). The tax is also applied in anon progressive manner which makes it less equitable. Some firms are forced to pay more than what they are supposed to pay in actual terms. Finally it may not be social optimal by the fact that some firms may layoff their employees so as to meet the cost of taxation. Due to these weaknesses of taxation, it is not emphasized by the government but instead a lot of emphasis is made on regulation. The government regulates the amount of production and consumption leading to externalities. This can be in form of quantity regulation in which the government can force the firms to produce the socially efficient quantity instead of taxing it forcing the firm to internalize the cost of the externality. Carbon emissions are another form of negative externality. Carbon emission from firms pollutes the surrounding environment resulting to an increase in social costs accruing to the third parties and it also forms part of greenhouses gases that promote global warming. Negative changes in the environment due to climatic condition variations can be attributed to carbon dioxide emissions. Coase Theorem provides a means by which this externality can be controlled; it lays emphasis on the need to have externalities internalized by the firms that produce them if the form of tradable emission permits. The theorem however has some limitations such as the free rider problem in which some agents can enjoy the benefits of a free environment without contributing towards it. It tends to work best in situations where externalities are not global but are in existence in a smaller context. Use of carbon trading provides a means of is to create a means putting a price on carbon emission. Thus it assists in internalizing environmental costs of firm and results in lower emissions. The government may also levy fees on each unit of pollutants that is being emitted into the surrounding environment. Setting emission standards provides a means of limiting the amount of pollutants emerging from a firm. Another form of negative externality is water pollution which results in the death of aquatic life as well as having some negative effects on the environment. Industrial effluents emitted by firms into major water bodies causes disease outbreaks. Acidic rain which is caused by water pollution brings about deforestation thus causing serious environmental degradation. Household water ...Download file to see next pagesRead More
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