Externalities

Lacsamana, Origines, Valero

Externality
An externality exists when the actions or decisions of one person or group impose
a cost or bestow a benefit on second or third parties

. Externalities can either be positive or negative. They can also occur from
production or consumption

Inefficient decisions result when decision makers fail to consider social costs and
benefits
Externality
Externalities are sometimes called spillovers or neighborhood effects.

Air, water, land, sight, and sound pollution; traffic congestion; nuclear accidents;
and second hand cigarette smoke are only a few.

The study of externalities is a major concern of environmental economics.

Externality
In the absence of externalities, when a firm weighs price and marginal cost to
decide output, it is weighing the full benefits to society of additional production
against the full costs to society of that production.

Those who benefit from the production of a product are the people or households
who end up consuming it.

The price of a product is a good measure of what an additional unit of that product
is “worth” because those who value it more highly already buy it.
Acid Rain and the Clean Air Act
Acid rain is an excellent example of an externality and of the issues and conflicts
involved in dealing with externalities.

When manufacturing firms and power plants in the West burn coal with a high
sulfur content, smoke from those plants mixes with moisture in the atmosphere.

The result is a dilute acid that is windblown to north and east, where it falls to
Earth as rain.
How does the acid rain problem look to the
different parties involved?
Party 1

•For manufacturing firms and public utilities generating the sulfur dioxide that
creates acid rain, burning high sulfur coal delivers cheap power and employment
to residents of the West.

•Paying to clean up the damage or changing the fuel mix to reduce sulfur would
result in higher electricity prices. As a result, some firms would likely go out of
business, and jobs would be lost.
Party 2 •For residents in other parts, particularly those near wildlife areas, the
burning of high-sulfur coal and the resulting acid rain results in fish kills and
deforestation

. •Often these citizens are far enough away from the power plants producing the
sulfur dioxide that they are not even benefiting from the cheaper power.

•As in many areas of economics, the hard issue here is how to balance benefits to
one set of claimants with costs to another. In complex cases of externalities, like
acid rain, often governments get involved.
Other Externalities

The most significant and hotly debated issue of externalities is global warming

. The 2007 Nobel Peace Prize was awarded to former Vice President Al Gore and
the Intergovernmental Panel on Climate Change, a group of 2,500 researchers
from 130 nations that issued a number of reports linking human activity to the
recent rise of the average temperature on Earth.

Although there is considerable disagreement, many people are convinced that

strong measures must be taken to prevent major adverse consequences such as
dramatically rising sea levels.

Individual actions can also create externalities. When you drive during rush hour,
you increase congestion faced by other drivers. If you smoke, someone’s health
may be compromised. Again the key issue is weighing the costs and benefits to all
parties
Private Solutions to Externalities
Government intervention is not always necessary to address externalities. Private
actors will sometimes arrive at their own solutions.

here are several types of private solutions to market failures:

1) Moral Codes

2) Charities

3) Business mergers or contracts in the self interest of relevant parties

1. Moral Codes
Moral codes guide individuals’ behavior. Individuals know that certain
actions are simply not “the right thing to do” or would elicit disapproving
reactions from others.

This is illustrated in the case of littering. The likelihood of being fined may
be small, but moral codes provide an incentive to refrain from littering.
2.Charities
Charities channel donations from private individuals towards fighting to limit
behaviors that result in negative externalities or promoting behaviors that generate
positive externalities.

The former can be seen in the case of organizations that protect the environment,
while the latter is exemplified through organizations that raise money for
education.
3. Business mergers or contracts in the self interest
of relevant parties

Two businesses that offer positive externalities to each other can merge or enter
into a contract that makes both parties better off.

Example:

PLDT Inc. and Globe Telecom, said in May last year that it would buy rival San
Miguel Corp’s telecommunications assets for P70 billion, effectively stopping the
entry of a third player in the industry hounded by complaints of bad service
The Coase Theorem
The theorem states that private economic actors can solve the problem of
externalities among themselves

. ● Transaction cost: The cost incurred in making an economic exchange,

such as the costs required to come to an acceptable agreement with the other
party to the transaction, drawing up an appropriate contract and so on.

two parties will be able to bargain with each other to reach an agreement that
efficiently addresses externalities.
● According to the theorem, the parties affected by an externality will bargain to
reach an outcome that will be more efficient

. ● Transaction costs must be low in order for parties to arrive at a more efficient
outcome.

● In the real world, transaction costs are rarely low, so the Coase theorem is often
inapplicable.
Govt shuts down 5 firms for violating environmental
laws
The cease and desist orders against the five companies were issued last July 22,
according to lawyer Jonas P. Leones, assistant director of the Environmental
Management Bureau (EMB) and secretary and legal counsel of DENR’s Pollution
Adjudication Board (PAB).

1) Victorias Sugar Milling Company

Victorias was shut down because its factory continued emitting dark smoke
from its chimneys despite ample time given to it to stem the pollution.
Ambient air samples taken from the surrounding areas of the sugar milling
firm showed a total suspended particulates (TSP) with a concentration of
790 micrograms per normal cubic meter, far above DENR emission
standards of 300 micrograms per normal cubic meter.
Govt shuts down 5 firms for violating environmental
laws
2. Asian Alcohol Corp. in Pulupandan

The Asian Alcohol factory produced effluents of 640 milligrams per liter,
which is way above the DENR standard of 150 milligrams per liter for total
suspended solids (TSS).

3. Seaside Seafoods Market and Restaurant

Seaside Seafoods Market and Restaurant violated the Water Pollution Act
when its wastewater exceeded the DENR effluent standards. The firm was
also slapped with a fine of P200,000 for every day that it violated the law.
Govt shuts down 5 firms for violating environmental laws

4.Mingson Mining Industries Inc. in Mandaue City, Cebu

Mingson Mining also produced smoke emission that overshot DENR

emission standards.

5.Tobi Marketing in Parañaque City, Metro Manila

a firm that makes snacks, after water samples from its nuts section were
found to be below DENR standards.
DENR fines 3 water firms P29.4M for violating Clean
Water Act
Maynilad (Maynilad Water Services Inc. or MWSI) distributes water to the metro’s
west zone while Manila Water (Manila Water Co. Inc. or MWCI), services the east
zone. The MWSS, also a private firm, regulates the two utilities.

If they failed to comply, a fine of P200,000 per day will continue to be imposed
upon them until such time that they have fully complied with the provision of
Section 8 of RA 9274," Atienza said in a separate statement

Private Firms
Corporate social responsibility

Corporate social responsibility (CSR) is a business approach that contributes to

sustainable development by delivering economic, social and environmental
benefits for all stakeholders.

The way it is understood and implemented differs greatly for each company and
country. Moreover, CSR is a very broad concept that addresses many and various
topics such as human rights, corporate governance, health and safety,
environmental effects, working conditions and contribution to economic
development. Whatever the definition is, the purpose of CSR is to drive change
towards sustainability
PRIVATE SOLUTIONS TO
EXTERNALITIES
How OceanaGold cover-up their
pollutive activities
 • Private solutions to externalities include moral codes, charities, and business
mergers or contracts in the self interest of relevant parties.
• The Coase theorem states that when transaction cost are low, two parties will
be able to bargain and reach an efficient outcome in the presence of an
externality.
• In practice, private parties often fail to resolve the problem of externalities on
their own.

Key Terms
• Transaction cost: The cost incurred in making an economic exchange, such as
the costs required to come to an acceptable agreement with the other party
to the transaction, drawing up an appropriate contract and so on.
• Coase Theorem: The theorem states that private economic actors can solve
the problem of externalities among themselves.
https://courses.lumenlearning.com/boundless-economics/chapter/private-solutions/
OCEANAGOLD
Media
Militarization
Didipio River

Bribery/threats/intimidation
Capitalism
PUBLIC SOLUTIONS TO
EXTERNALITIES
• Market strategy 1 - Counteractive Taxes and Financial Assistance
Example: For instance, two industries such as dyeing unit and footwear
manufacturing unit are each unloading 1000 tons of glop into a river every
year. The EPA decides that it needs to minimise the volume of contamination.
It considers two elucidations:
Regulation: The EPA could tell every industry to decrease its contamination
to 500 tons of glop every year.

Counteractive Tax: The EPA could impose a tax on every industry of

$100,000 for every ton of glop it unloads
• Government policies to reduce pollution
• Tax. e.g. Carbon tax, which makes people pay the social cost
of pollution.
• Subsidy. e.g. subsidy of alternative energy sources.
• Pollution permits, e.g. carbon trading schemes where firms
are given the right to pollute a certain amount; these
permits can be traded with other firms.
• Regulation. Limits on a number of pollutants that can be
discarded into the atmosphere.
• Changing consumer behaviour – e.g. through advertising,
nudges.

https://www.economicshelp.org/blog/11077/environment/policies-to-reduce-pollution/: ECONOMICS HELP

 PUBLIC SECTOR REMEDIES FOR
EXTERNALITIES
• The Environmental Protection Agency (EPA) was
formed in 1970 to provide public-sector solutions to
the problems of externalities in the environment. Public
policy makers employ two types of remedies to resolve
the problems associated with negative externalities: 1)
price policy: corrective tax or subsidy equal to marginal
damage per unit 2) quantity regulation: government
forces firms to produce the socially efficient quantity
• Paris Agreement
United Nations Framework Convention on
Climate Change (UNFCCC): greenhouse gas
emission
-US (Trump) decided to withdraw
• Example (Philippines): Sin Tax
https://courses.lumenlearning.com/boundless-economics/chapter/private-
solutions/

http://www.gmanetwork.com/news/news/nation/111555/govt-shuts-down-5-firms-
for-violating-environmental-laws/story/

http://www.gmanetwork.com/news/news/nation/176349/denr-fines-3-water-firms-
p29-4m-for-violating-clean-water-act/story/