Reducing Negative Externalities Through Government Intervention

How can government reduce negative externalities?

Unless the government intervenes, there will be too much production of products that have negative externalities.
Examples:
Too much paper (causing too much pollution)
Too much driving (causing too much climate change)
Too much playing loud music in apartments (causing too many disturbed neighbors) Too much of the human industrial activity that causes climate change (causing the sea level to rise, temperatures to rise, more droughts/famines, more bad storms, etc.)
Government can increase efficiency in a market economy by reducing negative externalities the correct amount.

How can government do this? By doing one or more of these things:
1. Tax products that are associated with negative externalities. (E.g. tax cars that have poor fuel efficiency.) This is a Pigouvian tax
2. Regulate production of the products that are associated with negative externalities. This is called direct controls. (E.g. require catalytic converters be installed on gasoline-powered cars.)
3. Tax the pollution itself. This is called an effluent fee
4. Government can auction a limited amount of permits that businesses must have if they want to emit pollution. This is called cap and trade.
How to reduce climate change: METHOD 1: EFFLUENT FEE (pollution tax) Carbon Tax: Tax the carbon content of coal, oil, natural gas
Tax on cement production
Tax on methane emissions
Tax on hydrofluorocarbons

These taxes will make it more expensive to do the things that cause climate change, so people and firms will do less of the things, so climate change will be reduced.
How to reduce climate change: METHOD 2: CAP AND TRADE
Cap and Trade has 3 components:
1. Government limits the amount of carbon dioxide that can be emitted per year in an economy,thus putting a "cap" on the overall amount of carbon emissions.
2. Government issues a limited amount of carbon permits- the right to emit carbon dioxide. By limiting the number of carbon permits, total carbon dioxide emissions are limited. (Government can either auction off these limited number of permits or give them away.)
3. After these permits are in the hands of the public, the government will NOT issue any more of them!!!! But people and firms can buy and sell (trade) the existing permits on a market that functions similar to a stock market.
Why is the market for trading (buying and selling) carbon permits important?
1. Because it means that the permits are valuable.
If a firm with carbon permits can figure out a way to reduce its carbon emissions, then it can make money by selling permits that it no longer needs. This gives firms an incentive to find cheap ways to reduce carbon emissions.
2. If the government wants to reduce carbon emissions in the country at a later date year from now, it can buy carbon permits in the market, then destroy the permits.

CAP AND TRADE: Summary
1. CAP: Government places a national limit on total annual carbon emissions in the nation, and makes it illegal for any person or firm to emit carbon without a permit from government.

2. PERMIT: Government issues only a limited number of carbon permits to make sure that the national limit on carbon emissions is not exceeded.
3. TRADE: After the carbon permits are issued, they can be bought and sold by people and firms on a new market that functions similar to a stock market. People and firms who sell a permit are no longer allowed to emit carbon; people and firms who buy a permit are allowed to emit carbon But. government often screws up.

Government can make the economy less efficient by reducing negative externalities too much.
Examples:
1. Ban paper production
2. Ban loud music
3. Ban driving
4. Ban coal, oil, and natural gas
The above things have benefits; if they are banned then these benefits are eliminated.

Note:
The efficient amount of pollution in a society is NOT "zero pollution."Human existence causes pollution. To have zero human-caused pollution, we would all have to die right now. It's impossible to "ban" pollution.Pollution is not caused only by evil corporations, Every human being,  including you and me, causes pollution.Positive Externalities: Spillover production or consumption benefits conferred on third parties without compensation from them

Examples:
1. You get a measles shot (benefiting people who will not catch the measles from you).
2. You keep your yard neat and your home maintained (benefiting your neighbors). Government can increase efficiency in a market economy by increasing positive externalities the correct amount.
How can government do this? By doing one of these:
1. Subsidize the products that are associated with positive externalities. This is a Pigouvian subsidy.
(Example: subsidize health care, especially with contagious diseases, so more people get immunized.)
2. Regulate production of the products that are associated with positive externalities. This is called direct controls.
(E.g. have deed restrictions requiring homeowners to keep their yards clean and homes maintained) How large is an economy?