Now, so we explained that there's an issue of property rights but of all of the times it is very difficult to assign property rights. So how do you solve the externality? In those cases. Well, it's got to be with some sort of government intervention. So, again, as we explained at the beginning of this of this week and also this section of externalities when you have a market for the externalities, it's a very good rationale, it's a very good reason for the government to exist. In order to enforce regulations to correct the externalities. But, still economists have a lot to say because the government has different options to solve the externality. That, that's a shown those three options which is in essence taxes permits and standards are kind of the most talked about or the most relevant ones. Say you have two companies in this area, Company A and Company B, and they're both between them producing polluting the water source in this community with 500 tons of gunk. Gunk is a really bad thing, right? It turns everyone who, who drink it green and dies and, you know, that is a, that's a really bad thing, that if you, you pollute a lot of those stuff it's really, really bad. Now the river is able, or the water source is able to assimilate some of this gunk and kind of process it to, to kind of get rid of it, right? The, the, the natural environment can take some of this pollution, perhaps. And, and assimilated, as soon as you, you don't pollute it a lot, you give it time to assimilate. So let's say that the government knew that the most gunk this water source could take is 200 tons of gunk let's say, per year. The time is not so relevant. Now, their goal is to reduce the amount of gunk that goes into the into the water source to 200. Or to set it up at that level. And you have two companies producing this. They have basically three options of doing it. They can set a standard for instance. They can tell each company the most you an produce is 100 tons of gunk each. And that will give you the 200 tons of gunk at the end. So the, the government can, kind of reach that optimal level of pollution of 200 tons of gunk by setting their regulation and telling each company exactly the amount of gunk that they can produce. So this would be, standard. Right? Regulations, ray regulation. Which is more like command and control. And this is the reason that this is the most prevalent way of dealing with the issue of externalities. Probably in the world, definitely in the US. The US in the 1970s set up the Environmental Protection Agency at the federal level. And you have environmental protection agencies at the state level, and the main source of the main source of the main reason why they are there is to set standards of how much pollution we can have, of different things in different industries, and to enforce those standards. So if company A produces more than 100 tons there will be a penalty. And if company B does the same thing, there will be a penalty. And that way we can make sure that those companies only produce that much, and the environment is protected. Now, but the, one of the problems with that, one of the reasons our economies don't like command and control standards like this to solve the externalities is because there's really no incentive for the companies to produce less than 100. If they produce 75 they don't pay the fee. And if they produce more than 100 then they pay a fee. But if they produce 50 there's no difference, right? So, therefore, a lot of economists actually like some kind of incentivized structure based on the number of pollution tons you have. Which is, the first one will be a tax. You can tax companies with the goal. So you can have a tax, a tax of, this is an example let's say of, $50,000, or $50 million per ton, right? And the goal of this tax is to, is to reduced pollution total for both companies, to, to 200. You can also achieve it by saying that the goal of this tax is to reduce the pollution by each company to a 100 tons per each. So this a different way. You can tell the company you have to, you cannot produce more than a 100, or you can charge them a tax that has a goal of forcing the company not to produce more than a 100. What is the difference between this tax and, and the standard? Well, one benefit of the tax is that it give an incentive to companies to produce less than 100. There's always an incentive to produce less. If the company produce 100 tons of gunk, they can always save money by producing less. Then a 100 and, and not having to pay that tax. So the tax, if, if well established, if it's, if, if the tax has a, the properties of being an effective tax can actually in, incentivize companies to, to pollute to a point that is lower than the optimal level of pollution. Now, the other thing that the government can do is say well, let's say that they, they have started they give each company, the 100 tons standard of gunk each. Now let's say that company B would like to produce 200 tons. Now perhaps company B can say to Company A, since they cannot produce 200, because the total is 200, Company B says to Company A, well since it costs us you know, a $100 million to reduce gunk from 200 to 100, we'll pay you $50 million if you reduce the 100 tons yourself. And company A might say, well actually it doesn't cost us very much to reduce pollution. It actually only cost us $25 million to reduce pollution to, by 100, so they can say, yeah, pay, you pay us 50, we're willing to reduce pollution by another 100. So in that situation, company A would produce no tons. And they will get the 50 million for company B. And company B will produce 200 tons, and they will have to pay the $100 million to reduce from 200 to 100. So in that situation the companies all together are saving money, and the government is still. Achieving the standard of 200. Now there has to be a way of trading those things. So in a way, what has happened here is that the companies have somehow managed to make polluting a market and what they're trading with each other is some kind of permit to pollute. So the third time, or the, another way of the government can actually achieve the 200 gunk is by issuing permits of pollution, let's say 100 to each company, and allowing the companies to trade those permits with each other. And the companies, these companies have to pay different amount of money to reduce pollution. There will actually be a possibility of having a market of permits in which companies that have to pay a high cost to reduce pollution can buy permits from those companies that don't have to pay a lot of money to reduce pollution. And in that sense, the com, the pollu, the same standard is achieved with the lessen of the cost which is actually better for society. Now obviously there is, is a very difficult process. We have some of the issues that we have with those which is that you have to have some kind of way of allowing companies to trade each other these permits. And when you are, when you have Companies polluting over, over the whole world. We have something like air pollution in which a company in the U.S. Pollutes the environment and at some point it's going to affect people on the other side of the world. It's very difficult to establish it's trading mechanisms with companies all over the world. But there's been an effort if you've been following and been paying attention. One of the proposals to deal with Asian climate change has been this, this proposal of issuing permits to, to countries that still have to pay a lot of money to reduce pollution. And the and companies, and countries that have achieved reducing reduction in pollution will be able to sell those permits to all the, to other countries. It hasn't happen yet but it hasn't had, it has been experimented in, in the US. In some industry, have been experimenting on their world level, kind of makes in, in paper like this idea of permits quite a bit. Because it achieve the same level of pollution, the optimal level of pollution or the loss amount of, the less amount of cost. Now in, in general, those are the three main ways that the government can try to internalize the externalities. But the main point here is that when we have the market failure such as externalities, we definitely have a justification for the government to, to intervene in markets. To, to try to fix, fix the problem of these externalities is some way. And we see the government doing this all the time. Not only in terms of pollution of companies, but also another big example is the tax on, on cars. Cars are a big source of externalities, not only because they pollute the environment, but also because they cause traffic congestion. So one of the reasons that government charges a gas tax is in order to correct that externality. In that particular case there is a justification for the government to charge that tax, so intervening markets, because if we let people use a common resource the way they want they will create an externality, and we all be worse off as a result. So, so that's conclude the, the issue of externalities, now let's, let's, let's, let's wrap the things up, and put the whole week in context. [music] Produced by OCE Atlas Digital Media at the University of Illinois, Urbana-Champaign.
