Sustainable Development Economy

Environmental Externalities and Government Intervention

GROUPS 3 :

Petrus Lois Goo Taghi NIM: 2207511025

Gery Alesandro Simbolon NIM: 2207511043
Ni Wayan Widarbayanti NIM: 2207511045
Ning Ai Satyawati NIM: 2207511046

LECTURERS
Dr. Amrita Nugraheni Saraswaty, S.E, M.Sc

FACULTY OF ECONOMICS AND BUSINESS

SUSTAINABLE DEVELOPMENT ECONOMIC 2023/2024
UDAYANA UNIVERSITY
2024
 Preface

Praise be to God Almighty. who has bestowed His grace and guidance so that we can
complete the scientific work on "Environmental Externalities and Government
Intervention”. We would also like to thank all those who have contributed to the preparation
of this scientific work. Of course, it will not be able to be maximized if it does not get support
from various parties. As compilers, we realize that there are still shortcomings, both in the
preparation and grammar of the delivery in this scientific work. Therefore, we humbly accept
suggestions and criticisms from readers so that we can improve this scientific work.

As for our concern in making our paper is:

1. An externality is an event that occurs because of another event occurring.

2. Externalities can be good or bad, often referred to as positive externalities or negative
externalities.
3. Externalities can also be generated when something is made (i.e. production
externalities) or used (i.e. consumption externalities).
4. Pollution caused by commuting to work or chemical spills caused by improper waste
storage are examples of externalities.
5. Governments and companies can correct externalities through financial and social
measures.

Jimbaran, Maret 2024

Author

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 Table of Contents

Preface .................................................................................................................................. 0
Table of Contents .................................................................................................................. 1
Understanding of Externalities .............................................................................................. 2
Types of Externalities............................................................................................................ 3
Negative Externalities ........................................................................................................... 3
Positive Externalities ............................................................................................................. 3
Production Externalities ........................................................................................................ 3
Consumption Externalities .................................................................................................... 3
Externality Solutions ............................................................................................................. 4
Taxes .................................................................................................................................... 4
Subsidies ............................................................................................................................... 4
Other Government Regulation ............................................................................................... 4
Real-World Examples of Externalities ................................................................................... 4
How Do Externalities Affect the Economy? .......................................................................... 5
What Is the Most Common Type of Externality? ................................................................... 5
Reference .............................................................................................................................. 6

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 Understanding of Externalities
Positive externalities are benefits that are infeasible to charge to provide; negative
externalities are costs that are infeasible to charge to not provide. Ordinarily, as Adam Smith
explained, selfishness leads markets to produce whatever people want; to get rich, you have to
sell what the public is eager to buy. Externalities undermine the social benefits of individual
selfishness. If selfish consumers do not have to pay producers for benefits, they will not pay;
and if selfish producers are not paid, they will not produce. A valuable product fails to appear.
The problem, as David Friedman aptly explains, “is not that one person pays for what someone
else gets but that nobody pays and nobody gets, even though the good is worth more than it
would cost to produce” (Friedman 1996, p. 278).
Admittedly, the real world is rarely so stark. Most people are not perfectly selfish, and
it is usually feasible to charge consumers for a fraction of the benefit they receive. Due to
piracy, for example, many people who enjoy a CD fail to pay the artist, which reduces the
incentive to record new CDs. But some incentive to record remains, because many find piracy
inconvenient, and others refrain from piracy because they believe it is wrong. The problem,
then, is that externalities lead to what economists call underproduction of CDs rather than the
nonexistence of CDs.
Research and development are a standard example of a positive externality, air pollution
of a negative externality. Ultimately, however, the distinction is semantic. It is equivalent to
say, “clean air has positive externalities and so clean air is underproduced” or “dirty air has
negative externalities and so dirty air is overproduced.”
Economists measure externalities the same way they measure everything else:
according to human beings’ willingness to pay. If one thousand people would pay ten dollars
each for cleaner air, there is a ten-thousand-dollar externality of pollution. If no one minds dirty
air, conversely, no externality exists. If someone likes dirty air, this unusual person’s
willingness to pay for smog must be subtracted from the rest of the population’s willingness to
pay to curtail it.
Externalities are probably the argument for government intervention that economists
most respect. Externalities are frequently used to justify the government’s ownership of
industries with positive externalities and prohibition of products with negative externalities.
Economically speaking, however, this is overkill. If laissez-faire that is, no government
intervention provides too little education, the straightforward solution is some form of subsidy
to schooling, not government production of education. Similarly, if laissez-faire provides too
much cocaine, a measured response is to tax it, not ban it completely.
Especially when faced with environmental externalities, economists have almost
universally objected to government regulations that mandate specific technologies (especially
“best-available technology”) or business practices. These approaches make environmental
cleanup much more expensive than it must be because the cost of reducing pollution varies
widely from firm to firm and from industry to industry. A more efficient solution is to issue
tradable “pollution permits” that add up to the target level of emissions. Sources able to cheaply
curtail their negative externalities would drastically cut back, selling their permits to less
flexible polluters (Blinder 1987).

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 While the concept of externalities is not very controversial in economics, its application
is. Defenders of free markets usually argue that externalities are manageably small; critics of
free markets see externalities as widespread, even ubiquitous. The most accepted examples of
activities with large externalities are probably air pollution, violent and property crimes, and
national defence.

Types of Externalities
Externalities can be broken into two different categories. First, externalities can be
measured as good or bad as the side effects may enhance or be detrimental to an external party.
These are referred to as positive or negative externalities. Second, externalities can be defined
by how they are created. Most often, these are defined as a production or consumption
externality.

Negative Externalities
Most externalities are negative. Pollution is a well-known negative externality. A
corporation may decide to cut costs and increase profits by implementing new operations that
are more harmful to the environment. The corporation realizes costs in the form of expanding
operations but also generates returns that are higher than the costs. However, the externality
also increases the aggregate cost to the economy and society making it a negative externality.
Externalities are negative when the social costs outweigh the private costs.

Positive Externalities
Some externalities are positive. Positive externalities occur when there is a positive gain
on both the private level and social level. Research and development (R&D) conducted by a
company can be a positive externality. R&D increases the private profits of a company but also
has the added benefit of increasing the general level of knowledge within a society.
Similarly, the emphasis on education is also a positive externality. Investment in
education leads to a smarter and more intelligent workforce. Companies benefit from hiring
employees who are educated because they are knowledgeable. This benefits employers because
a better-educated workforce requires less investment in employee training and development
costs.

Production Externalities
A production externality is an instance where an industrial operation has a side effect.
This is often the type of externality used as example, as it is easy to envision an environmental
catastrophe caused by improperly stored chemicals by a chemical company. Because of how
the company produced its goods or protected its waste, an externality occurred.

Consumption Externalities
Externalities may also occur based on when or how a consumer base utilizes resources.
Consider the example of how you get to work. Those who choose to drive are creating a
pollution externality by driving their own car. Those who choose to take public transit or walk
are not causing the same externality. Instead of a side effect occurring because something is
being produced, an externality is caused because of an item being consumed.

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 Externality Solutions
There are solutions that exist to overcome the negative effects of externalities. These
can include those from both the public and private sectors.

Taxes
Taxes are one solution to overcoming externalities. To help reduce the negative effects
of certain externalities such as pollution, governments can impose a tax on the goods causing
the externalities. The tax, called a Pigovian tax—named after economist Arthur C. Pigou—is
equal to the value of the negative externality.
This tax is meant to discourage activities that impose a net cost to an unrelated third
party. That means that the imposition of this type of tax will reduce the market outcome of the
externality to an amount that is considered efficient.

Subsidies
Subsidies can also overcome negative externalities by encouraging the consumption of
a positive externality. One example would be to subsidize orchards that plant fruit trees to
provide positive externalities to beekeepers.
This nudge has the potential to influence behavioural economics, as additional
incentives one way or another way dictate the choices that are made. The subsidy is often
placed on an opposing item to detract from a specific activity as well. For example, government
incentives to upgrade to more energy-efficient renovations subtly discourages consumers
against options with more externalities.

Other Government Regulation

Governments can also implement regulations to offset the effects of externalities.
Regulation is considered the most common solution. The public often turns to governments to
pass and enact legislation and regulation to curb the negative effects of externalities. Several
examples include environmental regulations or health-related legislation.
The primary issue with government regulation of externalities is the need for consistent
and reliable information to track the externality is being managed or overcome. Consider
regulation against pollution. The government put forth resources to ensure that the legislation
put in place is being followed, including holding bad actors accountable for not properly
addressing their externality.

Real-World Examples of Externalities

Many countries around the world enact carbon credits that may be purchased to offset
emissions. These carbon credit prices are market-based that may often fluctuate in cost
depending on the demand of these credits to other market participants.
One program within the United States is the Regional Greenhouse Gas Initiative
(RGGI). The RGGI is made up of 12 states: California and 11 Northeast states. RGGI is a
mandatory cap-and-trade program that limits carbon dioxide emissions from the power sector.

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 Different agencies are imposed a cap on externalities, though they can trade resources
to change what their cap is. Agencies that struggle managing their externality (i.e. pollution)
may need to purchase additional credits to have their cap increased. Other agencies that conquer
their externality may sell part of their cap space to recover capital likely used to overcome their
externalities.

How Do Externalities Affect the Economy?

Externalities may positively or negatively affect the economy, although it is usually the
latter. Externalities create situations where public policy or government intervention is needed
to detract resources from one area to address the cost or exposure of another. Consider the
example of an oil spill; instead of those funds going to support innovation, public programs, or
economic development, resources may be inefficiently put towards fixing negative
externalities.

What Is the Most Common Type of Externality?

Most externalities are negative, as the production process often entails byproducts,
waste, and other consequential outcomes that do not have further benefits. This may be
pollution, garbage, or negative implications for worker health. Many externalities are also
related to the environment, as the mechanical nature of manufacturing and product distribution
has many detrimental impacts on the environment.

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 Reference

Econlib. (n.d.). Externalities. Acces: https://www.econlib.org/library/Enc/Externalities.html

Econlib. (n.d.). Market Failures, Public Goods, and Externalities. Access:
https://www.econlib.org/library/Topics/College/marketfailures.html
Hesda, A. R. (2018, April 20). Intervensi Pemerintah Dalam Perekonomian: Bagian I
Ringkasan Sejarah. Access:
https://www.djkn.kemenkeu.go.id/artikel/baca/12670/Intervensi-Pemerintah-Dalam-
Perekonomian-Bagian-I-Ringkasan-Sejarah.html
Krueger, A. O. (1990). Government failures in development. National Bureau of Economic
Research.
Prasetiya, F. (2012). Modul Ekonomi Publik: Bagian 1 Peran Pemerintah dalam
Perekonomian. Acces: http://ferryfebub.lecture.ub.ac.id/files/2013/01/Bagian-I-
PeranPemerintah.pdf