Question

Describe the conceptual issues associated with externalities in both space and time. Discuss policy options for the control of regional pollutants such as acid rain. Analyze the level of economic efficiency of each option.

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Answer 1

The externalities are side effects of the consumption or production which are faced by third parties. These externalities are not taken into the account the external effects and thus in case of negative externalities, firms tend to overproduce and it is inefficient outcomes. Externalities have space and time effects. The effects of pollution tend to decrease in faraway spaces. The area of emission would face the larger negative externalities.

Following are the two best option to combat the problem of negative externalities:

• The imposition of the Pigou tax would cause the internalization of externalities and the firm would tend to reduce the output level and thereby the pollution also declines.
• The allocation of permits through the government would also reduce the externalities. It would force the firms to internalize the negative externalities.

The Pigou tax would not be effective to control the externalities if the demand is inelastic or consumer behaves inelastically. Thus, here the government can collect the larger tax but it can not reduce the output to efficient level here. thus here we must go for the permits to control the externalities.