Question

1. Give three ways in which the government can intervene and solve for spillover costs.

Answer 1

There are primarily three things government can do:

1)Government can play a role in reducing negative externalities by taxing goods when their production generates spillover costs. By taxing, effectively the cost of producing such goods is raised. This cost reflect the true cost of production as it includes spillover costs. The use of such a tax is called internalizing the externality. Such taxes include pollution tax, environemental texes etc.

2)Legislation: Government can use regulation to outlaw any action which is causing spillover costs.In cases of air and water pollution, the most direct action is a legislation prohibiting or limiting the pollution. It can also permit civil lawsuits by private parties to recover damages for negligent actions.

3)Government can play a role in encouraging positive externalities by providing subsidies for goods or services that generate spillover benefits. Government subsidy is a payment that effectively lowers the cost of producing a given good or service. This includes both subsidizing consumers (for example, to correct the underallocation of resources to higher education, the U.S. government provides low-interest loans to students) and subsidizing producers (publicly subsidized immunization programs, hospitals, and medical research).