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Correcting externalities
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Governments can use several policies to reduce external costs. Each has strengths and weaknesses.
Taxes and subsidies
Taxation: tax goods with external costs (such as fuel) to raise their price and cut consumption. Raises revenue, but may hit poorer people hardest and is hard to set at the right level.
Subsidies: pay producers of goods with external benefits, or of cleaner alternatives (such as electric buses). Encourages them, but costs the government money.
Subsidies: pay producers of goods with external benefits, or of cleaner alternatives (such as electric buses). Encourages them, but costs the government money.
Fines and regulation
Regulation: laws that limit harmful activity, such as emission limits or bans.
Fines: penalties for breaking regulations.
These are clear and direct, but must be enforced, which costs money, and fines may be too small to change behaviour.
Fines: penalties for breaking regulations.
These are clear and direct, but must be enforced, which costs money, and fines may be too small to change behaviour.
Pollution permits
The government sets a total limit on pollution and issues permits to firms.
Firms that pollute less can sell their spare permits to firms that want to pollute more.
This rewards cleaner firms and caps total pollution, but setting the limit is difficult and monitoring is costly.
Firms that pollute less can sell their spare permits to firms that want to pollute more.
This rewards cleaner firms and caps total pollution, but setting the limit is difficult and monitoring is costly.
A government wants to reduce car pollution in a city. Suggest one policy and one drawback.
- A congestion charge or fuel tax raises the cost of driving.
- It may hit low-income drivers hardest.
Answer: A congestion charge; it may be unfair on poorer drivers.
Policies: taxes, subsidies, fines, regulation and pollution permits. Taxes raise revenue but may be unfair; subsidies cost money; regulation needs enforcing; permits cap pollution but are hard to set and monitor.
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