Explain why environmental pollution is regarded as a source of market failure? Evaluate three different policies the Government could use to reduce the market failure.

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                       Economics Essay 2                                      

Economics Essay: Explain why environmental pollution is regarded as a source of market failure? Evaluate three different policies the Government could use to reduce the market failure.

This essay will explain the reasons for environmental pollution being regarded as a source of market failure and will also assess three different policies, which a government could use to prevent market failure.

Firstly, environmental pollution refers to the many pollutants, which harm the environment. These are usually harmful gases and wastes. The main constituents of environmental pollution are: carbon dioxide emitted, greenhouse gases, water pollution caused by firms disposing pollutants and wastes into rivers, congestion as well as Global Warming. In this essay the specific example of carbon dioxide will be used.

Carbon dioxide is a major greenhouse gas and is produced by a combination of fossil fuels. (Oil, gas, coal and petrol etc) Carbon Dioxide is also an example of a negative externality or a negative spill over effect. Externalities occur when there is a difference between private costs and social costs. A private cost is the cost a producer bears whereas a social cost is one which includes the private costs as well as the cost of others, also known as external costs. Carbon Dioxide has many external costs for example, poor health, Climate change, and this in turn all these will prove to be a cost of the government in terms of provision of health services as well as man power in terms of reduced hours of work due to sick leave.

For instance, take the scenario of a chemical company which produces steel and in the process it also emits carbon dioxide into the atmosphere. Here the private costs to the company would be the costs of the labour, raw material etc. The Social cost would then include the private costs and would also take into consideration the external cost of emitting carbon dioxide. These costs may include: poor health for surrounding residents, contribution to global warming and climate change. In this case a negative externality occurs as the company may make a little or no payment towards the external costs to the environment.  

Private companies aim to maximise profits and in order to do so they try and minimise private costs without paying much attention to the external costs. This in turn increases the gap between the marginal private costs (MPC) and the marginal social costs (MSC) A chemical company may not treat its waste and pollutants such as carbon dioxide, before releasing them in to the environment in order to reduce costs. Although this would be reducing their private costs it would still be increasing the social costs to others such as the government.

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Below is a diagram, which illustrates how negative externalities arise:

From the diagram one can see that market failure is caused due to the overproduction of goods and services, which aren’t accounted for. S1 is the supply curve when only private costs are taken into consideration. S2 is when social costs are taken into the consideration. As firms minimise costs they are able to produce more at a lower price as shown at point A (when only private costs have been ...

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