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.
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