Negative externalities are seen as an example of market failure. Discuss, with examples, the policies a government could use to improve the misallocation of resources.

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Negative externalities are seen as an example of market failure. Discuss, with examples, the policies a government could use to improve the misallocation of resources.

Private actions, which are conceived in order to eliminate the problem caused by external effects are significant, but often fail to attain their ultimate goals. Generally speaking, it is difficult to organize a strong movement against harmful company practices. After all, the external costs, as well as the external benefits, quite often have an impact on a large number of people. Therefore all who suffer because of these costs cannot easily be tallied.

It is not easy to count everyone who has suffered from the smoke and soot coming from factory chimneys. In this case government interference is usually required. There are quite a few methods of calculating the external effects and in every specific case the government should choose the most appropriate. It would be possible to conduct a poll of all the people to see who is affected by the air pollution and how much they would be will to pay to either reduce or eliminate the pollution entirely. Conceivably, one person might be willing to pay 20 pounds per annum for clean air, another person might be willing to pay 2000 pounds per annum, and yet another might not be concerned with the pollution at all and unwilling to pay anything. The poll would be quite extensive, as it would not only concern those whose breathing is affected by the pollution, but also those with a vested interest in the protection of wildlife, the preservation of their buildings, etc. This would only scratch the surface of the problem, as more information would be needed in order to completely ascertain the amount of damage caused by the pollution and how this would affect the individual’s life. For instance, one would need to ask whether the paint stripping from the walls of a shop owner’s place of business has contributed to loss of profits as potential customers shop elsewhere due to the deteriorating look of the store. Using this information, one can determine how much it would be worth to the shop owner to reduce the amount of pollution in the area. Most likely the shop owner would respond that he would be willing to pay X amount of pounds if pollution were reduced 5%, Y amount if pollution were reduced by 10%, Z amount if pollution were reduced by 15%, and so on. However, one must keep in mind that this is a simplified break-down of the many problems caused by negative externalities and that the issues run much deeper than the afore-mentioned example.

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 In order to achieve the competent allocation of resources in areas in which externalities exist, the government can choose from a wide range of policies. For example, the price of such effects can be fixed by charging for parking in the most crowded parts of the city. In addition, the government can take severe measures such as taxes or subsidies on external effects. For instance, increasing tax rates for uninhabited houses can compensate for external costs, because of the growing presence of homeless persons and a general shortage of housing. Conversely, at the expense of subsidies, exemplified by covering ...

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