Regulations have been the most preferred method of dealing with externalities, particularly environmental externalities, but economists...

Regulations have been the most preferred method of dealing with externalities, particularly environmental externalities, but economists prefer taxes. Explain and illustrate why this is the case.

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The term externality refers to the cost / benefit that affects a third party in spite of not choosing to incur / benefit. This happens when the equilibrium price of the product / service does not reflect the true cost / benefit of that product / service.

As said above,regulations have been the most preferred method of dealing with externalities, particularly environmental externalities.

But the economists prefer taxes because of a different reason.

Example of environmental externality - Smoking cigarettes ,drinking alcohol etc.,

Take the example of India where the government has the both ways in place :

Here there are both regulations as well as the very taxes imposed on these products

Regulations - Include "No Smoking" in public spaces.Only can smoke in dedicated "smoking areas"

Taxes - Taxes on cigarettes for example range from 38% to 78% depending on the price range and variety.

Economists prefer Taxes due to the following reasons :

1.If Only strict regulations are imposed,they will not be successful as these habits are very addictive in nature.As they are addictive but since the trade is restricted,it leads to increase in illegal trade in these products which is not good for the economy.

2.If very strict restrictions are imposed,the govt.looses the revenue from the sale of these products.

3.If at all the high taxes are imposed,they increase the tax revenue for the government and the govt.can spend this additional revenue in fulfilling the important needs and welfare activities of it's citizens

4.With the increased tax revenue from the sale of these products,the govt can spend it to improve the infrastructure (like providing " Dedicated Smoking Areas" so that the smokers will not affect the NON-SMOKERS ; it can also use the funds to educate and create awareness campaigns about the ill-effects of smoking in order to discourage smoking.

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Rahul Sunny answered 1 year ago

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