ENVIRONMENTAL POLICY AND EXTERNALITIES
Externalities are one the most important topics in economics. Externalities are economics refers to the benefits and costs of production / or consumption that are not compensated. Externalities can be positive and negative and consequently having its own implications on the market equilibrium (Arnold, 2008).
In the case of positive externalities, benefits are offered to the third party who is neither a buyer nor a seller in a market economy. For example, fitting a bulb outside one’s house can be a simple example of a positive externality. This action will not only lighten one’s own house are but will also benefit those who pass-by, stand or live nearby that very house. Graphically, the positive externalities can be depicted as follows:
(Jain, Khanna, & Sen, 2010)
The rise of demand from D to D’ results in excessive cost that in turn leads considerable losses equivalent to the shaded area. In case of positive externality:
SOCIAL BENEFIT (MARGINAL) > PRIVATE BENEFITS (MARGINAL)
Contrary to this, the negative externality is a simple reverse of positive externalities. Negative Externalities includes those productions and consumptions that have a negative impact on the third party who is neither a buyer nor the seller. Example of a negative externality includes various activities such as misuse and mistreatment of the public property, etc. The negative externalities in term of graph can be depicted as follows:
(Jain, Khanna, & Sen, 2010)
At the market equilibrium point OQ1, the excessive social cost is higher than the benefit gained by the society and so requires reduction to point OQ2 to deal with negative externalities. Hence, in case of negative externality the social cost will be as follows:
SOCIAL COST (MARGINAL) = PRIVATE COST (MARGINAL) + EXTERNALITY (MARGINAL)
IMPACT OF EXTERNALITIES
Understanding and dealing with the externality is critical as it results in the rising parity between the social cost and private cost incurred in the production and consumption in a competitive market. This contradicts the free market situation where social cost equates the private cost.
ROLE OF GOVERNMENT IN DEALING WITH EXTERNALITIES
The role of the government is critical in dealing with the externality situations that result in the inefficient and malfunctioning market that is competitive in nature. This malfunction or failure results as the cost of the externality is not paid by any party (buyer or supplier) in the market. Government plays this role by defining regulations for the industries such in terms of what and how is to be produced.
Dealing with negative externalities ensures that regulatory binding for reduction on production and consumption. This process is known as the internalization of externalities (Jain, Khanna, & Sen, 2010). Such as increasing taxes and imposing laws to discourage these activities. The efforts are directed by objective to bring the private cost closer to the social cost. Additional obligations in terms of the taxes and obligations are imposed. For the positive externalities, the prices are paid by government in the form of subsidies, etc.
In both cases, government attempt to bring the market close to equilibrium. However, easier said than done; the internalization of externalities is often faced with challenges. For instance, there is no scale to measure the social cost of the destroyed social properties that have immense negative impact on the lives of people living in that particular area. Also, the negative reputation of that area resulting from the negative externalities cannot be quantified too.
Arnold, R. (2008). Economics. Mason, OH: South-Western Cengage Learning.
Jain, T. R., Khanna, O. P., & Sen, V. (2010). Development and Environmental Economics and International Trade. FK Publications.