Regulation in Externalities - Whether Positive or Negative - Essay Example

Externalities Table of Contents Introduction 3 2. Externalities 3 3. Regulation in Externalities- Whether Positive or Negative 4 3 Standards ofRegulation and Prohibitions 5 3.2 Quantitative Limits 5 3.3 Tax Imposition 6 4. Politics of the Economy and Regulations towards Externalities 6 5. Conclusion 8 6. References 9 1. Introduction The research paper is aimed at incorporating the concept of externalities and the role of regulation towards addressing externalities. The entire research paper will be framed on the basis of a given situation of a multi-billion dollar listed commercial property trust, Profit Ltd. The trust is composed of 40 commercial office towers each valued at 5 billion dollars. The report will be designed evaluating the phenomenon as to whether a regulation in externalities would give rise to either positive or negative consequences. On the basis of the consequences, implications will be generated regarding whether Profit Ltd should embrace upon changes due to consideration of externalities or it should attempt to resist the change with the help of lobby groups. The objective of this research paper is to incorporate comprehensive understanding of the concept of externalities and various issues in relation to regulations towards externalities. 2. Externalities Externalities occur when the producers or consumers of goods and services unintentionally create indirect impacts upon other producers or consumers of goods and services (Zilberman, 1999). Externality is such an aspect of the economy that although it does not depict any monetary effect upon the producers or consumers of goods and services but bears an impact upon the society’s standard of living. Most of the economists consider externalities to be a market failure. This is because upon the occurrence of externalities, the market prices do not represent the actual marginal costs or benefits coupled with the goods and services dealt with in the market. The concept of externalities can be prominently associated with the activities related to production or consumption or both. Both production as well as consumption externalities occur when the respective activities of production and consumption of one individual inflicts costs and benefits towards the other individuals that are not spread precisely in the course of various market operations (Zilberman, 1999). Externalities can be either positive or negative. Positive externalities occur when the individuals’ actions generate benefits for the other individuals. The concept of positive externalities can be best understood through citing the example of technological overrun. The positive externalities in this regard occur when an invention of a firm benefits the entire society due to the technological up gradation along with the firm. On the other hand, negative externalities occur when the action of one individual generates harmful impacts upon the other individuals within the society. The best example of negative externalities is the emission of pollution by an industrial unit. In economic terms, the activities concerning positive externalities generate more amounts of benefits to the society than to the private sectors. In the same way, the activities concerning negative externalities induce more amounts of costs to the society than to the private sectors. These facts about externalities indicate that under the phenomenon of externalities, there is difference between the private benefits (costs) and social benefits (costs). Due to the prevalence of this difference, inefficiencies within the resource allocation occur (Sankar, 2005). 3. Regulation in Externalities- Whether Positive or Negative In determining the positivity or negativity of regulations towards externalities, the nature of the latter is required to be comprehensively addressed. The producer of the goods and services are not accustomed towards taking into consideration the costs and benefits that are generated towards the society due to their production activities. Under this circumstance, the amount of production of the producer gets hampered. The producer either generates production in greater volume when externalities induce costs or produces in lesser quantities when benefit is ascertained to externalities. The role of the regulation comes into play when it is required to persuade the producers towards making alterations in amounts of production. In other words, the regulations are forms of controlling measures towards externalities. 3.1 Standards of Regulation and Prohibitions Regulatory standards and bans, although are considered to be effective regulations towards externalities, impact the producers bluntly. These standards fail to produce results generating optimum amount of production. The firms that are prepared financially to pay for the fines being imposed due to the standards would strive for generating the externality, thus making the regulation negative. 3.2 Quantitative Limits The second type of regulation that can be enforced upon externalities is that of putting limit upon quantities. In this regard, the producers are allowed to generate externalities up to a certain limit. The limits can be imposed by the regulatory bodies by compelling the firms to pay fines or through several conditions upon licensing. The limits, in this case, are set in such a manner that the benefits to the producer due to an extra unit of externality is equivalent to the extra amount of costs being put upon the society by the firm. If the determination of limits most efficiently cannot be ensured by the regulators, there would be possibilities of inefficiencies. For example, the inefficiently set limits can give rise to either extremely low or extremely high generation of externalities. 3.3 Tax Imposition The other mode of controlling externalities by the regulatory bodies is through the imposition of tax upon the production of the firms. This option is preferably chosen by the economists. This method has the benefit that induces the producers to select the most effective productive level, considering both the external as well as private costs. This controlling method towards externalities has an indication towards inducement of positive regulations (Forsyth, 2001). 4. Politics of the Economy and Regulations towards Externalities It was argued by the renowned economist George Stigler (1971) that the regulations may be desired by the consumers or the producers since they are of the notion that the regulators can be captured by them. Through the term ‘capture’, the economist aimed at mentioning that the producers or the consumers can persuade the regulators through either direct or indirect means to endorse regulators that promote their own or their groups’ interests. One of the foremost intentions of the producers or consumers is to influence the regulators towards generation of rents with the help of regulatory activities. The interest groups are concerned about distributing the rents back to them. The rents are nothing but economic profits, indicating profits that are more than the opportunity costs, e.g. generation of rents by the regulations in the tax revenue structure. The regulators must think of determining ways through which inefficiencies can be prevented. The inefficiencies would arise as the money would be removed from the economic system. If a specific interest group stands in a position to receive the tax revenue, then that specific interest group would lobby in order to transform those regulations into act. This might even happen that the interest groups would allocate resources to generate access to the rents being developed by the regulators. Moreover the probability of the interest groups towards getting the rent can be enhanced with the help of lobbying regulators. In the above mentioned actions of the interest groups along with the regulators, out bursting losses are incurred towards the society. This is because the resources that are utilized by the interest groups do not assist in creation of any important goods or services for the individuals. Furthermore, an enormous amount of the rents being generated with the help of lobbying regulators might be dispersed off by the expenses towards seeking for rent. The dispersed benefits from rent can never be utilized for the betterment of the society and can never be recognized by the economy. Due to the inefficiencies of the regulatory standards and prohibitions, the interest groups often influence the regulators to choose the same against tax which has been proved to be efficient thus far. The failure of the regulatory standards generates more rent for the interest groups. Rent would arise, in this context, because the obligation of the standards leads to decrease in supply of the products being obligated. This in turn enables the producers to cite greater prices for their products and hence create ‘monopoly rents’ (Zilberman, 2002). 5. Conclusion The company concerned in this research paper, Profit Ltd. should embrace the change to be generated by the regulations’ considerations towards externalities. This can be argued on the basis of the various facts being generated through the entire discussion in this research paper. The company should instigate the notion within its commercial activities that a transaction may harm or diminish the social benefits, if externalities in the form of costs or negative externalities prevail. The negative externalities might pose seriously biased or ethical issues within the society. This would, in turn, would deteriorate the company’s image and reputation within the society. On the other hand, if the company can generate positive externalities through its commercial activities, entirely opposite consequences would prevail. In other words, positive externalities would enhance the level of utility for the society and that would be achieved at ‘zero cost’ to the company as a whole. The regulatory approaches are effective means towards inducing positive externalities and the company should cooperate with the regulatory requirements for grasping future benefits for its own operational concern. The company, in spite of striving towards achieving the large rents through lobbying regulators, should endeavor to embrace change. The process might take longer time periods in achieving monetary profits for the company. But it should be positive in this respect for the betterment of both of its commercial activities as well as that of the society. 6. References Forsyth, P., 2001. Environmental Externalities, Congestion and Quality under Regulation. Infrastructure Regulation and Market Reform. Online] Available at: http://www.regulationbodyofknowledge.org/documents/178.pdf [Accessed October 17, 2011]. Sankar, U., 2005. Environmental Externalities. Madras School of Economics. [Online] Available at: http://coe.mse.ac.in/dp/envt-ext-sankar.pdf [Accessed October 17, 2011]. Stigler, G.J., 1971. The Theory of Economic Regulation. Bell Journal of Economics and Management Science 2(1), 3-21. Zilberman, D., 1999. Externalities, Market Failure, and Government Policy. University of California at Berkeley. [Online] Available at: http://are.berkeley.edu/courses/EEP101/Detail%20Notes%20PDF/Cha03,%20Externalitites.pdf [Accessed October 17, 2011]. Zilberman, D., 2002. Negative Externalities and Policy. University of California at Berkeley. [Online] Available at: http://are.berkeley.edu/courses/ARE253/2004/handouts/negativeexternalities.pdf [Accessed October 17, 2011]. Read More