Government Tools

Government tools: Anexternalityarises when a person engages in an activity that influences the well-being of a bystander but neither pays nor receives compensation for that effect.(Mankiw, 2021).Externalities come in many forms. Negative externalities lead markets to produce a larger quantity than is socially desirable. Positive externalities lead markets to produce a smaller quantity than is socially desirable. Whether it is pollution released into the air from a factory (negative externality) or the restoration of a historical landmark (positive externality), when people cannot solve the problem of externalities privately, the government often steps in.Possible government responses include:  Legislation – enacting specific laws. For example, illegal to deal in inside trading and selling shares before the release of profits warning.  Direct provision of merit and public goods – governments control the supply of goods that have positive externalities. For example, by supplying high amounts of education or police force.  Taxation – placing taxes on certain goods to discourage use and internalize external costs. For example, placing a tax on unhealthy foods to offset costs of medical care to treat obesity and diabetes.  Subsidies – reducing the price of a good based on the public benefit that is gained. For example, lowering college tuition because society benefits from more educated workers. Subsidies are most appropriate to encourage behavior that has positive externalities.  Tradable permits – permits that allow firms to produce a certain amount of something, commonly pollution. Firms can trade permits with other firms to increase or decrease what they can produce.  Extension of property rights – creates privatization for certain nonprivate goods like lakes, rivers, and beaches to create a market for pollution. Then, individuals get fined for polluting certain areas. Supply and Demand Equilibrium: When a market is in equilibrium, the price determines which buyers and sellers participate in the market. Those buyers who value the good more than the price choose to buy the good and buyers who value it less than the do not. Similarly, those sellers whose costs are less than the price choose to produce and sell the good and sellers whose costs are greater than the price. Governments exact laws to regulate price called price controls. When the government levies a tax on a good, the equilibrium quantity of the good falls. That is, a tax on a market shrinks the size of the market. The simulation showed how policy intervention can have a large impact on the supply and demand curve. For example, in the simulation from selling robot dogs you either had to pay a nuisance fee or have a license to own one. The nuisance fee can be considered a tax that will raise the cost of the product. The number of licenses were limited and if a business produces more products than there are licenses available those extra units will not be able to be sold. In the simulation the nuisance fee is imposed in response to the negative externality of barking dogs and the license was imposed in response to the positive externality of the dog being able to protect the owners’ home. Consumer or Producer Surplus: Policy interventions can lead to both consumer and producer surplus based on the type of intervention used. One example is a price ceiling. A price ceiling is a legal maximum on the price of a good or service. An example is rent control. This price is typically less than the free market equilibrium price leading to a consumer surplus. On the opposite end of the spectrum would be a price floor which is a legal minimum on the price of a good or service. An example would be the federal minimum wage. A price floor will lead to a surplus as producers make more due to the higher price while consumers demand less.