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Market Failure: Externalities
Government Policy Options
Economics Textbooks Boundless Economics Market Failure: Externalities Government Policy Options
Economics Textbooks Boundless Economics Market Failure: Externalities
Economics Textbooks Boundless Economics
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Economics
Concept Version 6
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Regulation

The government can respond to externalities through command-and-control policies or market-based policies.

Learning Objective

  • Describe the role of government regulation in addressing externalities


Key Points

    • Command-and-control regulation requires or forbids certain behaviors with the goal of addressing an externality.
    • Regulation is difficult to implement and enforce correctly.
    • Command-and-control regulation can come in the form of government-imposed standards, targets, process requirements, or outright bans.
    • The allocation of tradable permits is a market-based policy that has been primarily used to combat pollution.

Term

  • Negative Externality

    A detremental effect suffered by a party due to a transaction it was not a part of.


Full Text

The government can respond to externalities in two ways. The government can use command-and-control policies to regulate behavior directly. Alternatively, it can implement market-based policies such as taxes and subsidies to incentivize private decision makers to change their own behavior.

Command-and-control regulation can come in the form of government-imposed standards, targets, process requirements, or outright bans. Such measures make certain behaviors either required or forbidden with the goal of addressing the externality . For example, the government may make it illegal for a company to dump certain chemicals in a river. By doing so, the government hopes to protect the environment or other companies or individuals that use the river that would otherwise suffer a negative impact.

No Smoking

The prohibition of smoking in certain areas is a regulation designed to reduce the negative externalities suffered by non-smokers when they are around smokers.

In practice, implementing regulation effectively is difficult. It requires the regulator to have in-depth knowledge of a certain industry or sphere of economic activity. If done incorrectly, regulation can introduce inefficiency. For example, if the government makes it illegal to dump in the river, the companies and their customers may suffer because the products must be produced using less efficient methods. On the other hand, if the government allows too much to be dumped in the river, they have failed to mitigate the negative externality.

If the government is unsure of how to effectively regulate the market, it should seek other methods of mitigating the externality. Advocates of market-based policies for reducing negative externalities point to the difficulty of creating and enforcing effective regulation for reasons why the government should create systems of incentives and disincentives instead of using the force of regulation.

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