Answer to Question #67247 in Microeconomics for Esther muema

Question

Define the concept of externalities and explain four remedies to negative externalities?

Answer 1

Externalities exist when actions of economic units creates benefits and/or costs to third party, where the latter is a not direct par­ticipant.

Sale of Pollution Rights:
When producers pollute the environment, the government may auction off pollution rights. Auc-tion of pollution license by the government will lead to competition among the producers (i.e., the buy¬ers) so price of license will increase as also the costs to the firms. To avoid this cost, the firms may try to check pollution in advance in their own interests.

Regulation:
The government can regulate external disecono¬mies by passing laws. Scooter accidents often cause a lot damages to scooterists (and public). To reduce these damages, the government may make (and does make) wearing helmets a must for the scooterists.

Voluntary Payment:
By this method external diseconomies can be avoided if the parties creating them voluntarily pay to those who are suffering from diseconomies.

Directive:
The government may circulate directives stressing the need to keep the environment clean. The problem is that directives are not binding; hence they are often ignored.