what do you understand by externalities ? explain the piguobian method and coase method for dealing with externalities.
Answers
externalities means the process of consuming or producing certain goods, there are harmful and beneficial side effects that are borne by people who are not directly involved in the market exchange. these effects are called externalities.
◦ Negative Externality: The externalities which have negative effects on the well being of the third parties are called negative Externality.
◦ Positive Externality: The externalities which have positive effects on the well being of the third parties are called positive Externality.
PigouvianTheory :
A Pigouvian tax is taxes are a corrective tax that are used to address market failures occure due to negative externality.
By determining the per-unit tax equal to the marginal external cost (other than the smoker), a person can achieve socially efficient results.
PigouvianTheory and Subsidies :
when there are external benefits, market output is low. when you have a subsidy is equal to the external benefit of the goods. It shifts the demand curve up and makes the market efficient. The new market equilibrium is efficient equilibrium. A Pigouvian subsidy therefore reduces deadweight loss and increases social surplus.
Alternatives to Pigouvian Methods
=> Direct regulation
=> Creating new markets
Coase Theorem
If the cost of transactions is low and property rights are clearly defined, then personal deals will ensure that equilibrium in market is also efficient even if there are externalities
Conditions for the coase theorem to be made, define property rights and reduce transaction costs may often not be met but even so the theorem does suggest an alternative approach to externalities.
The theorem suggests another solution mainly for the creation of new markets.
If government can define property rights and reduce transaction costs then markets can be used to control externality problems.
Externalities is the result of an activity (industrial or commercial) that has an effect on other parties, without reflecting on the market price. This effect could be positive or negative.
Pigouvian method is the method of taxing negative externalities, with the intention of correcting an inefficient or undesirable market outcome.
According to the Coase theorem, when there are externalities and transaction costs are low, parties will be able to discuss and reach a suitable solution.