Question

Discuss at least four possible remedies to externalities

Answer 1

Externalities are factors that cause a change in someone's utility without that person being responsible for it. It can be both positive, like education and rule of law, and negative, like pollution.

Some traditional remedies of externalities are-

1- Taxes. They are particularly useful in negative externalities when a market corrective mechanism is preferred. If negative externalities are produced, the social marginal cost is higher than the private marginal cost, leading to overproduction. O change this, taxes can be levied to align the social marginal cost with the social marginal benefit so that the social optimum is produced.

2- Subsidies. This is used to encourage positive externalities. In case of positive externalities, the social benefits are higher than the private benefit. Subsidies can sync the two for the social optimum.

3- Quotas and bans- These are more blunt methods. A givrrgover can simply regulate the quantity directly, like asking a polluting firm to shut down.

4- Change in organisational structure- A major reason of externalities is that they are not internalised by the producer in their optimisation problem. For example, a chemical factory, polluting the river, doesn't take into account it's effect on the fisheries. So combining these firms can force internalisation and correct externalities.