• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

Discuss the view that the free market economy encourages negative externalities and thus the size of the public sector should be increased.

Extracts from this document...


Discuss the view that the free market economy encourages negative externalities and thus the size of the public sector should be increased. "Almost everything we do has some third-party effects, however small and however remote" said Milton Friedman. External effects have been studied by economists ever since the days of Marshall and Pigou. Often, the existence of externalities has been cited as one of the reasons why markets fail. Because of the existence of externalities, it is claimed that the market will fail to achieve a Pareto optimal allocation of resources and that the government must intervene and use taxes, subsidies, restrictions, quotas, etc to remedy the situation. However, it is spurious to claim that the problem of externalities is a result of the free market economy. The failure is not in the market but in the failure to clearly define and enforce property rights and the problem of negative externalities is not unique to the free market economy. Furthermore, the question presents a logical fallacy; even if the free market economy does encourage negative externalities, it does not follow that the size of the public sector should be increased, as the government may not be the best candidate for intervention. To prove the validity of this statement, one must prove that firstly, the problem of negative externalities is unique and is innate to the free market economy. Secondly, that the problem of negative externalities is detrimental enough to warrant intervention, thirdly that the government is necessarily the best candidate to intervene and lastly that the current level of intervention is insufficient and thus inadvertently, the size of the public sector should be increased. During the course of my essay I would prove how the problem of negative externalities lies not in the failure of the market, secondly, how negative externalities do warrant intervention and how the government should intervene to a certain extent. ...read more.


Mises pointed out that "some people choose certain modes of want satisfaction merely on account of the fact that a part of the costs incurred are debited not to them but to other people". The inherent selfish nature of people that while on one hand guides the market economy, on the other hand causes external costs. However, it is virtually impossible to define property rights for everything such as the environment. It is terribly difficult to define property rights for the air that we breathe or the oceans, this will be elaborated upon later. The fact that it is impossible to define and enforce property rights for everything coupled with human nature renders the problem of negative externalities a persistent one, one that is hard to eliminate completely. In the neo-classical externalities theory as explored earlier, negative externalities cause a difference between marginal social cost and marginal private cost and thus the resulting output level is greater than the Pareto optimal level, there is and over production or consumption of goods with negative externalities. As shown in the diagram below, assuming no external benefits, due to the presence of external costs, the marginal private cost is less than the marginal social cost. The resulting output level of Qe is more than the ideal Pareto outcome of Q* and the deadweight loss incurred by moving from Q* to Qe is shown by the shaded triangle. Hence, negative externalities are detrimental as they result in a less than optimal allocation of resources. Too much of society's scarce resources are diverted into the production of this good, representing a waste of society's resources which could have been put to better use somewhere else. ...read more.


Property rights define who owns property, to what uses it can be put to, the rights other people have on nit, etc. Property rights can be extended completely such that everyone would be able to prevent others from imposing costs on them. The Coase theorem states that in a perfectly competitive market with no transaction costs, the sufferers from the externalities can make deals with the perpetrators, the externality would be internalised and the socially efficient level of output would be achieved. In practice however, this can be totally impractical. Especially in instances where a large group of people is slightly inconvenienced, it is virtually impossible to expect all the sufferers to make bargains with the perpetrators. Also, it is impossible to define property rights for entities like air or oceans as mentioned before. In this case, the state is the best to set up such an institution as the state has the legislative, executive and judicial powers to enforce property rights and thus allow the free market to function. However the second part of the statement in the question is also fallacious, as even if the government should intervene, it does not mean that the size of the public sector, which includes everything in the public domain from public utilities to public provision of health services, should be increased. Hence in conclusion, the existence of negative externalities should not be blamed on the free market as the failure is in defining and enforcement of property rights and while the onus is on the government to provide an institution of properly defined and enforced property rights, it does not mean that the size of the public sector should be increased. Perhaps efforts at solving the problem of negative externalities could be improved especially in the area of pollution. ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our GCSE Economy & Economics section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related GCSE Economy & Economics essays

  1. Peer reviewed

    Cigarettes are demerit goods which cause negative externalities. B

    4 star(s)

    According to the diagram above, the quantity transferred in the market drops from qp to qs first, and then, to qt. This method is very common nowadays, especially for anti-smoking, anti-drink and anti-drug campaigns. Also, government can add taxes on certain products.

  2. Main characteristics of free market economy

    to solve the basic economic problem of "what, how, for whom to produce" in accordance with their self interest and satisfaction. As a result, the production of goods and services will be determined by the supply and demand of the good which will inevitably develop price and non-price competition between

  1. Outline the ways in which the price mechanism allocates resources in a free market ...

    bad harvest the supply goes down to A., and price goes up to B. The farmer produces more the next year to meet new demand at high price. Demand then goes down due to over supply. The equilibrium price is not reached when there is either too much demand or supply.

  2. The Role of the Informal Sector in the National Economy.

    Special efforts and attention is given to small scale entrepreneurs and one of the main objectives of this strategy is to encourage income-generating activities amongst vulnerable groups. The Mozambican experience shows that the informal sector has had a positive effect on economic growth.

  1. Free essay

    What are the main characteristics of a free market economy and centrally planned economy?

    energy, and communications because it is very unlikely any private industry will control those businesses as they provide low profit, but the government providing these subsidies, they will be accessible for all of society and not only those who can afford it.

  2. The Nature of Macroeconomics

    * Economic growth = increasing real GDP * Expanding national productive capacity, increasing the quantity of goods and services produced in an economy * Nominal GDP = current prices x output * Real GDP = constant prices x output What is the significance of economic growth?

  1. An Empirical Investigation into the Causes and Effects of Liquidity in Emerging

    The index used for emerging market sovereign bonds is the JP Morgan Emerging Market Global Bond Index (EMBI-G), which is a widely used benchmark for investors and allows a broad representation of the types of instruments available in emerging bond markets.

  2. Outline the main features of a market economy and compare it to a Command ...

    of people, whereas in a command economy the whole bureaucracy is left up to the state. Also again incentive weakens the economic growth, as there is little incentive for entrepreneurs to enterprise in a state economy, as that individual will not receive the benefits of that enterprise whereas in a free-market economy they would.

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work