Positive and negative externalities
An externality is a consequence of an economic activity that affects people outside of the transaction.
Positive externalities are when the consumption of a good or service has positive benefits for some external party. For instance, when people choose to buy new hybrid and electric cars, they generate less pollution and
greenhouse gases. This is good for everyone. When people buy exercise equipment like bicycles it can help to keep them fit and reduce the strain on health services.
Negative externalities are when an economic activity has a negative impact on an external party to the transaction. When people consume alcohol and cigarettes, they increase their risks of certain
illnesses and this creates a strain on health services. The production of certain products can have significant environmental impacts. Commodities like lithium are in high demand for use in electronics but their production
causes significant environmental damage.
Government policies to correct positive and negative externalities
The government uses taxation, subsidies, state provision, information provision, legislation and regulation to try to correct positive and negative externalities.
Taxation
Excise duties are placed on goods with negative externalities like cigarettes, alcohol and petrol. The idea is that this increases prices and so leads to a left shift of supply as firms have to give over more in taxes. This
causes a contraction of demand. However these goods tend to have very inelastic demand and so this tends to have a greater effect on raising revenue for the government than reducing sales of the product.
VAT is charged at a lower rate on or not at all on some products considered to be essentials or to have positive externalities. Most fresh food, children's clothing and medicines attract no VAT while some energy
saving products attract a rate of just 5%.
Effects of using taxation to correct externalities
VAT is a regressive tax. So are excise duties. This means they have a greater effect on low income earners than high. This is because they represent a greater proportion of income for a low earner. This means that
while high taxes on goods with negative externalities may reduce their consumption they may also increase the gap between rich and poor. Reducing indirect taxes can have the opposite effect.
High taxes can lead to black markets for goods. Smuggled cigarettes cost the government loads of money in lost revenue and may have been made in unsafe or unsanitary conditions. Many counterfeit cigarettes that
have been seized have been shown to have toxic chemicals in them.
As mentioned earlier, excise duties do more to raise revenue than quell demand. If this money is used to put towards the health services that will be needed this can be beneficial.
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Subsidies
Subsidies are the governments way of making goods with positive externalities more appealing by lowering the cost to produce them. This leads to either a right shift of supply if the subsidy goes to the supplier
or a right shift of demand if they go to the customer. Both are likely to increase the consumption of goods with positive externalities.
Effects of using subsidies to correct externalities
The elasticity of demand for a product will determine how effective subsidies are in increasing consumption. The benefit of subsidies is cheaper products but as with all government spending there is an opportunity cost
to be considered. Some people may feel the subsidy money would be better spent elsewhere.
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State provision
This refers to the services the education and health services that the government provides. These are considered to be basic needs. By providing them free for all, the government ensures everyone is entitled to
healthcare and education raising the standard of living for those that may not otherwise be able to afford it.
Effects of using state provision to correct externalities
Private education and health providers are still available to those that can pay for them. In terms of education, it may be that even amongst government schools the quality of teaching may vary, with schools in
deprived areas often underperforming those in more affluent areas.
With health care the government provides it free of cost but demand can be high leading to long wait lists for important operations. Those that can afford private health care are able to pay to avoid these queues.
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Legislation and regulation
Legislation and regulations are the laws and rules that govern the way individuals and businesses behave in the economy. This criminalises guns, drugs and drink driving which can all lead to significant negative
externalities for society. It also sets in place health and safety regulations firms must follow to keep employees safe and production standards that ensure consumers are not injured by defective products.
Effects of using legislation and regulation to correct externalities
Making things illegal can also lead to black markets for those goods. Ensuring that laws and regulations are enforced also costs money. So there is a trade-off between public safety and cost.
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Information provision
The government often runs public service campaigns to promote positive externalities e.g. the five a day fruit and veg campaign and to discourage negative externalities such as campaigns about gambling addiction.
Effects of using information provision to correct externalities
The level of interest the campaign garners from the public will have a big effect on how successful this is. Goods with inelastic demand like cigarettes, alcohol and gambling are inelastic because of their addictive nature.
It will be harder for these campaigns to convince people to quit.
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Exam style questions
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Questions
Explain with an example what a positive externality is. (2 marks)
When an economic action has a positive effect on a 3rd party(1) such as when someone buys and plants trees which help absorb CO2 making the environmentbetter for all.(1) Allow other examples.
Explain with an example what a negative externality is. (2 marks)
When an economic action has a negative effect on a 3rd party(1) such as when people consume fuel and it releases CO2 into the atmosphere.(1) Allow other examples.
Explain what is meant by the distribution of wealth. (2 marks)
The way in which wealth is shared(1) amongst the population of a country.(1)
Explain what inheritance is. (2 marks)
When a person dies(1) and they pass on their wealth to people in their family.(1)
Case study/Scenario
Fly-tipping is a crime which blights communities, poses a risk to public health and the environment, and costs up to £392 million a year. Local authorities dealt with 1.13 million fly-tipping incidents in 2020/21, up by 16% from
2019/20. To help combat fly-tipping there are £450,000 of new council grants to fund measures such as CCTV and ANPR cameras to help with enforcement.
Evaluate the impact of this program on combatting fly tipping. (6 marks)
Sample answer:
Additional CCTV cameras and ANPR cameras could help to identify and charge offenders{AO2} and this might reduce the chance of them re-offending.{AO3a} However, it may just move the problem to another location without
cameras.{AO3b}
There is a significant cost attached and this is money some feel would be better spent elsewhere.{AO3a} The extent to which it is successful in reducing fly tipping will determine its effectiveness.{AO3b}
If the government spends this money on improving enforcement of the legislation and it reduces the costs associated with fly tipping by more than it's cost then it seems like good value for money. If it is not seen to reduce fly tipping
The overall impact will be determined on whether it reduces fly-tipping or just moves it somewhere else in which case it will not have been effective.{A03b}
Case study/Scenario
In the UK we have the National Health service or NHS. The aim of the NHS is to ensure everyone has access to medical treatment. There are always calls for the government to spend more on the NHS. For some operations ther are long
waiting lists and the UK's aging population isn't helping matters.
Evaluate the costs and benefits of providing state healthcare. (6 marks)
Sample answer:
If a lot of people could not afford healthcare it would be more likely for dieases to spread{AO2} leading to more work time lost to illness{AO3a}and lower ooutput.{AO3a}
However, even though the NHS is
free to the public you may have to face long waits for certain operations.{AO3b} The amount that should be spent to reduce these would always be debatable as there is an opportunity cost to any government spending.{AO3b}
Government provision of health services helps everyone who could not otherwise afford them but is more beneficial to those that don't suffer long waits.{AO3b}