Question

Discuss two cases of externalities, one positive and one negative, that affects you directly. This could be something as simple as a neighbor driving a noisy and heavy polluting truck, or the city planting new trees along a road which are pleasant to look at and also help remove carbon from the atmosphere etc.

• What are the economic outcomes associated with each externality, in terms of how it effects consumer and/or producer surplus?
• What is the socially optimal quantity relative to the open-market outcome?
• Could the Coase Theorem work to generate efficiency (i.e. is there low bargaining/transaction costs and clearly defined property rights) or might the market failure be best addressed by some regulatory authority?
• How might regulation incentivize those generating the externality to internalize their external effect and move society closer to the socially optimal quantity?
• In your response to another student's post, offer an alternative solution or insights you have from personal experience with a similar externality.

1-3 paragraphs

Answer 1

positive externality (PE): My neighbour has planted aloe-vera form which i also benefit by sometimes plucking the aloe-vera leaves and use it.

negative externality(NE) : There is cattle farm next to my house and sometimes there is cowdung in front my house.

(1). with PE, economic outcome is underproduction i.e. less quantity is produced than socially desirable quantity. Here, consumer surplus is more than the producer surplus. Whereas, with NE, economic outcome is overproduction i.e. more quantity is produced than is socially desirable. Here, producer surplus is more than consumer surplus.

(2). In PE, socially optimal outcome is more than the open mareket outcome. And in NE, socially optimal outcome is less than the open market outcome.

(3). Coase Theorem can work to generate efficiency as compared to some regulatory authority. As when transaction costs are significantly low, then Coase theorem argues that before allocation of property rights, the parties can reach an efficient outcome by bargaining with each other. here, in PE, me and my neighbour can bargain and achieve at an efficient outcome where my neighbour can charge me some price for using his aloe-vera and thus he can produce more aloe-vera. In NE, i can bargain with the farm owner and build a fence around the cattle farm.

(4). Regulation is of 2 types:

i. control and command : here the regulatory authority can make certain action actions illegal or legal and can deal with externalities. But this method is not so efficient in incentivizing the parties to internalize externality caused by their actions.

ii. Market-based instruments: in case of PE, government can provide subsidy to the producer and thus incentivizes him to internalioze the externality and produce socially optimal quantity. In case of NE, government can either impose tax or give tradable permits or quotas to the producer. Taxes increases the cost of production , whereas quotas set a limit on production. both these methods incentivise the producer to internalize the externality and produce socially optimal quantity.