Gov Solutions to negative externalities

Question 1

What happens when consumers and producers do not consider the external costs of their actions ?

Answer 1

They will end up over consuming and overproducing. This ends up being a welfare loss

Question 2

How can the government prevent welfare loss ?

Answer 2

They can intervene with indirect tax. A tax on goods and services

Question 3

What will an indirect tax do ?

Answer 3

The government will make production more costly for producers through indirect tax. There will be an increase of costs for producers. They will no longer overproduce as the costly tax will deter them from overproducing

Question 4

What is the effect on the diagram because of this tax ?

Answer 4

The MPC will increase the MPC shifting the MPC curve upwards to MPC + tax. It will intersect with the socially efficient equilibrium point.

Question 5

In what way will this increase in tax on negative externalities ONLY work ?

Answer 5

The government have to choose the perfect size of the tax. This is because if the tax is too small, MPC will shift up a bit but not enough to reach the socially efficient equilibrium point. It needs to set the size of the tax equal to socially efficient equilibrium.

Question 6

What do we say happens to the negative production externality after this indirect tax is set by the government ?

Answer 6

It has become internalised. The government has fixed the negative production externality. It has also got rid of the overproduction of that good.

Question 7

How can we use indirect tax to fix negative consumption externalities? (diagram)

Answer 7

As there is no diagram for this, we can show this on a demand and supply diagram just be shifting supply upwards by the tax. This reduces the equilibrium quantity to a lower quantity of socially equilibrium quantity. This reduces the oversumption of harmful products

Question 8

What does the government use indirect tax for ?

Answer 8

They use it to internalise negative externalities and to reduce overconsumption or overproduction of harmful products

Question 9

What is another way government can correct negative externalities ?

Answer 9

Cap and trade system

Question 10

Who introduced the cap and trade system ?

Answer 10

EU’s Emission trading scheme

Question 11

What was the point of the cap and trade system ?

Answer 11

It was used to reduce carbon emission to slow down global warming

Question 12

How does a cap and trade system work ?

Answer 12

A cap when a government sets a limit on how much pollution a firm is allowed each year. This cap is an estimated socially efficient level of pollution. It will then divide its permits between firms until the cap is reached.

Question 13

If the European government sets a cap of 2bn tonnes of carbon and one permit of their allows 1 tonne of carbon, how many permits will it have ?

Answer 13

2bn permits

Question 14

What happens when the government gives a certain number of permits until a certain percentage of permits is reached ?

Answer 14

Once the government reach their last 10% of pollution permits, the government will auction these to producers.

Question 15

How is this auction of permits beneficial towards the government ?

Answer 15

It will raise revenue for the government, they will be able to increase chances of subsidising Eco friendly companies and fund renewable energy

Question 16

What type of firms will receive the most permits ?

Answer 16

Firms who produce the most goods will receive the most firms.

Question 17

What will these pollution permits become and what will firms be able to do ?

Answer 17

It will become tradeable and firms will be able to trade them with other firms and sell to those who need it

Question 18

If firm A finds it costly to reduce pollution and eco friendly technology being expensive for them, through the help of tradeable pollution permits what will they do ?

Answer 18

They will try to buy permits from firm B who find it much cheaper to switch to eco friendly technology and renewable energy resources and pollute less.

Question 19

Why will firm A buy more of the permits ?

Answer 19

To pollute more

Question 20

What happens to overall pollution through this cap and trade system ?

Answer 20

It would stay the same as firm A would produce a bit more and firm B would produce less.

Question 21

What can tradeable pollution permits be able to do ?

Answer 21

They will keep pollution under the cap set by the government in this most efficient way possible.

Question 22

Why is this the most efficient way to go about reducing pollution ?

Answer 22

Firms with the lowest costs are given incentives by the government to reduce pollution and would be able to sell of their pollution permits at a profit to the firms who find it costs to reduce pollution. These lowest cost firms will be able to reduce the most pollution.

Question 23

What is a third way government can reduce the consumption of harmful products ?

Answer 23

A minimum price. The lowest price suppliers of a good can legally sell for.

Question 24

What does minimum price do to prices of those harmful products ?

Answer 24

This will keep prices of those harmful products high and reduce quantity demanded low. This will lower the overconsumption of those goods low. For example, alcohol.

Question 25

Where does the minimum price have to set at and why ?

Answer 25

It will be set above the equilibrium price. This is because it will prevent prices to fall back to equilibrium prices and keep prices at Pmin line. This reduced QD and overconsumption

Question 26

What happens when there is a minimum price set above the equilibrium price ?

Answer 26

It creates an excess supply

Question 27

Why can’t suppliers drop price to eliminate this excess supply ?

Answer 27

Because legally the price cannot go below Pmin.

Question 28

If the market is in a disequilibrium, why might this be a good thing ?

Answer 28

QD will fall and reduce the overconsumption of harmful goods.

Question 29

What is a fourth way government can reduce market failure ?

Answer 29

Regulations

Question 30

What is an example of regulations being used ?

Answer 30

The 1997 firearms act made it illegal to purchase a hand gun in the UK. They address to the law to solve market failure.

Question 31

Does regulations always be strict ?

Answer 31

It can be strict towards things which has huge external costs to society like banning handguns and drugs. However, it can be less strict for example with smoking they have made it a LEGAL requirement to put on the packaging that smoking kills and to not smoke in public areas. Even ban advertisement on cigarettes on TV. This way they try to reduce the negative consumption of externalities

Question 32

What is a way the government use regulations to reduce negative production externalities ?

Answer 32

For example, because of pollution cars have meet certain environmental requirements to be legally sold. Factories have to meet minimum environmental standards to operate like the pollution permits

Question 33

What are the big uses of governmental regulations.

Answer 33

To ban goods completely, to set environmental standards and to set legal age restrictions.