2.8.3 - External cost policies

Question 1

List the 4 external cost policies

Answer 1

• Taxation
• Regulation
• Tradable permits
• Reducing demand

Question 2

Pros and cons of taxation

Answer 2

Pros:
- Effective way of reducing production and consumption
- Revenue can be used to compensate affected third parties

Cons:
- Can reduce welfare in low income groups
- Increasing business costs lowers profit and may lead to business failure
- Can make domestic firms uncompetitive internationally
- Can cause unemployment

Question 3

Pros and cons of regulation

Answer 3

Pros:
- Can be target more specifically than taxes
- Less likely to lead to price increase

Cons:
- Cost of implementing is high
- Parallel markets
- Business costs may increase; higher prices
- Loopholes around regulations can be found

Question 4

Pros and Cons of Tradable permits

Answer 4

Pros:
- Creates incentive system that is more effective than tax
- facilitates innovation

Cons:
- complicated and expensive system
- has to be controlled at an international level
- may lead to business costs meaning higher price

Question 5

Pros and cons of reducing demand

Answer 5

Pros:
- Advertising does not add to business costs
- Effective long term because it changes consumer behavior

Cons:
- opportunity cost
- Effectiveness difficult to measure