Sometimes market activities (production, buying, and selling) have unintended po

Question

Sometimes market activities (production, buying, and selling) have unintended positive or negative effects outside the market's scope. These are called externalities. As a policy maker concerned with correcting the effects of gases and particulates emitted by and local power plant, answer the following questions:
1.What two policies could you use to reduce the total amount of emissions?
2.Why do you think they each would work?
3.What would the benefits of each action be (besides emissions reduction)?
4.What would the costs of each action be?
5.How would you decide what was the best level of emission reduction?

Explanation / Answer

1.What two policies could you use to reduce the total amount of emissions? The government might respond to the negative externality in three ways: (1) Regulation (a command and control policy); (2) Corrective taxes; or (3) Tradable pollution permits. Regulations prohibiting pollution beyond some level is good but it is very difficult in practice as doing so successfully requires the government to have lot of information about the industries their pollutants and about the alternative technologies that those industries could adopt to control the negative externality. As this measure cannot be implemented efficiently the government follows either of the remaining So the two policies a government can adopt are (1) Corrective taxes; or (2) Tradable pollution permits. 2. Why do you think they each would work? These two policies work in this fashion: Corrective taxes are taxes enacted to deal with the effects of negative externalities. These taxes are designed to induce private decision-makers to take into account the social costs that arise from a negative externality. The taxes should be levied by an amount such that the market optimum quantity equals to the socially efficient output. IF we do not consider the negative externality the output will be more. But a corrective tax increases the cost of production and reduces the level of output equal to the socially desired or social optimal level. Economists prefer corrective taxes to regulations as a way to protect the environment from pollution because they can reduce pollution at a lower cost to society. They believe that corrective taxes reduce pollution more efficiently, saying that corrective taxes are better for the environment because they reduce the cost of environmental protection. The disadvantage of corrective taxes is that the government needs to know a lot of information to set the right amount of tax. Tradable pollution permits: In this approach government sets a certain limit on the pollution. And they either distribute or auction the right to pollute to the firms in the form of tradable pollution permit. As a result, the government does not need as much information about the firms’ technology. The government can simply set a limit on the total amount of pollution, issue permits for that amount, and allow the firms to trade the permits, thus reducing pollution while allowing economic efficiency. The disadvantage of pollution permits is that the government may not set the right overall level of pollution. 3.What would the benefits of each action be (besides emissions reduction)? A corrective taxes gives revenue to the government. A tradable pollution permit will generate revenue only when they are auctioned. If they are distributed among the firms they will not generate any revenue to the government. 4.What would the costs of each action be? The disadvantage of corrective taxes is that the government needs to know a lot of information to set the right amount of tax. Cost of colleting right information costs a lot to the government. And there is cost of implementation needs to be included. The disadvantage of pollution permits is that the government may not set the right overall level of pollution. Here the government need not have to spend more amount on implementation but it has to spend amount on colleting the data for setting the right amount of pollution. 5. How would you decide what was the best level of emission reduction? As both the policies are effective, the right one to be implemented depends on the type of industry or pollutant we can decide the right approach

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