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Explain the meaning and significance of externalities, how they arise and to what extent they can be corrected by government intervention.

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Introduction

Explain the meaning and significance of externalities, how they arise and to what extent they can be corrected by government intervention. This essay evaluates the importance and essentialness of government intervention in relation to externalities. The essay discusses, defines and analyses the significance of externalities with reference to real life situations and all the forms that externalities can arise, in addition it shall argue the main principles and characteristics of government intervention on externalities. In this essay it will demonstrate how business organisations have been effected by externalities. Externalities has been defined as 'An economic side effect, externalities are costs or benefits arising from an economic activity that affect somebody other than the people engaged in the economic activity and are not reflected fully in prices'1 Externalities arise in four forms, from production or consumption and they can be either negative externality or positive externalities. If it is negative then it will impose an external cost, if it is positive then it will provide an external benefit. * Negative production externalities occur when production has a detrimental effect in other markets in the economy. The negative effects could be felt by other firms or by consumers. The most common example of negative production externalities involves pollution or other environmental effects. ...read more.

Middle

The OECD introduced the environmental tax in 1972; the tax went by the principle of 'the polluter pays'. This meant that the polluter would pay towards the cost of the measures taken to reduce pollution, a fee that is decided by the public authorities. Problem with environmental taxes is if taxation is too high, in part a result of the problem of assigning accurate monetary values to the external costs created by producers and consumers, the result can be the expansion of grey markets where producers and consumers try to avoid the taxes. It is also hard to pinpoint precisely who is causing the pollution, in the case of pollution along rivers where several industrial plants might be emitting effluents. Should producers be subject to a consistent tax regime when some are more at risk of polluting than others? A further problem with using taxes to control externalities is that some taxes have a regressive effect on people on low incomes. Good examples to use would be the increased real level of duty on cigarettes and alcohol and the impact this has on households on below average incomes. Private solution - The Coase theorem is the proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own ...read more.

Conclusion

Many economists use the idea of externalities as the basis for public policy recommendations: a tax or subsidy to "make up" the external costs. In fact, most government functions at one time or another have been justified on the basis of externalities. To conclude government intervention on externalities can help to a certain extent when it is in the interest of the public. Perhaps the question of whether externalities warrant government intervention must be decided on the specific circumstances. "The greatest economic lesson of this decade is that except in textbooks, government failure is broader, more damaging, and more threatening to individual liberty than market failure ('The Economist'). Bearing this in mind, externalities (which are forms of market failure) must only warrant intervention when deemed absolutely necessary, not at any time, any place, or anyhow. Positive externalities can be subjective, as different people may well view costs and benefits differently. They occur in the natural course of economic activity and there is little need for any sort of governmental intervention to correct them. Nor is there any certainty that the government could accomplish this. If the actions that create the externality are actions taken in a free environment and in good faith, then the indirect benefits to others are not unjust to those that bear the cost. As long as those who bear the costs reap the benefits they wanted, their investment is a worthwhile one to them. ...read more.

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