Question

There is growing scientific research that human activity is leading to global climate change. Auto emission and burning of fossil fuels releases carbon dioxide other gasses into the air and scientists warn about the “greenhouse effect” and warming temperatures and reduced air quality.

Define and explain how the concepts of external cost or externalities, social cost and private costs apply to the analysis of this issue.

Should the government impose a higher tax on the price per gallon of gasoline to shift the external cost on to purchasers and reduce also reduce demand and consumption?

Answer 1

Externality refers to the costs or benefits that affects a party who did not choose to incur that cost or benefit . As for example , in this case industries burn fossil fuels to produce goods . Now the locatity situated just beside a manufacturing unit is affected by the pollution generate . The locality did not initiate the production and also does not get any profits from the production but it has to bear the costs of pollution . This is an example of negative externality . Now we come to the concept of social and private costs .

Private costs for a producer of a good or a service include the costs the firm pays to purchase capital equipment, hire labor, and buy materials or other inputs to carry on the production process .

Whereas social costs  include both the private costs and any other external costs to society arising from the production or consumption of a good or service . External cost refers to cost to society , regardless of who pays it .

Private Costs + External Costs = Social Costs

If the firm does not take pollution control measures then the external costs are borne by the society ( cost of pollution ) .

Higher tax on price per gallon of gasoline would create a distortion in gasoline market and also make it costly for common people . Rather a pollution tax would be more useful . Instead of inflating fuel price , Government can impose a pollution tax on per unit pollution generated