Question

Discuss the extent to which you agree with the view that taxation is the optimal method that will ensure fewer resources are allocated to the production and consumption of goods that create negative externalities.
Word Limit: 700 words

Answer 1

Externality refers to a consequence of an economic activity that affects a third party and this can be divided Into positive and negative externality. Positive externality refers to benefits(MEB) enjoyed by the third party as a result of a firm's action but for which the party has made no payment. Example- park. Negative externality refers to negative costs or consequences faced by a third party due to the firm's or individual's action as induced when the MEC(marginal external cost ) is not taken into consideration. Example - smoking, discharge of effluents into a nearby river.Corrective taxes or Pigovian taxes is an optimal method as it increases the cost of production hence reducing the quantity produced therefore reduced externality . With respect to consumption due to an increase in price the consumer too will look for alternatives or reduce its demand for the product . Thefore the taxes induces both producer and consumer to look for alternate or cleaner greener technology.Whereas Coase was against the taxation structure as found it inappropriate as traditionally A causes harm to B then A is made liable but the real question is whether A should be allowed to harm B or B to harm A.His view on externality is that bargaining will allow parties to effectively and efficiently address externalities but this is possible only under certain conditions like low transaction cost, perfect information, and well-defined property rights.This cannot be applied in reality hnece taxation is a more realistic method to mitigate negative externality .