Negative externalities

Negative externalities presentation

1. Negative Externalities EdExcel Economics 1.3.2

2. Negative Production & Consumption Externalities Negative externalities occur when production and/or consumption impose external costs on third parties outside of the market for which no appropriate compensation is paid. Negative production externalities Negative consumption externalities Air pollution from factories Fly-tipping of household waste Damage to the environment from industrial ocean fishing Effects of passing smoking External costs of fertilizers and pesticides used in farming Impact on family life of gambling and alcohol addiction Noise pollution from the airline industry Noise pollution from events such as sports matches and concerts

3. Examples of Negative Production Externalities Negative production externalities include pollution generated by a factory that imposes costs on others When answering any question on negative externalities – consider whether the external costs are significant and if so, whether they can be measured and valued accurately

4. World Carbon Dioxide Emissions from 2005 to 2014

5. Negative Externalities in Production – Market Failure Output Marginal Private Cost P1 Q 1 Marginal Private Benefit N egative externalities causes social cost > private cost Costs, Benefits £s Marginal Social Cost Q 2 P2 The equilibrium level of output delivered by a free market is at Q1 where MPB = MPC and it is allocatively inefficient. We assume in this example that there are no externalities arising from consumption Note If MSC pivots away from MPC then the marginal external cost of extra output is assumed to be increasing

6. Negative Externalities – The Social Welfare Loss Output Marginal Private Cost P1 Q 1 Marginal Private Benefit Market failure happens when prices do not reflect social costs Costs, Benefits £s Marginal Social Cost Q 2 P2 This is the area of social welfare loss because the market output supplied is higher than the social optimum Note The deadweight loss of social welfare happens when MSC > MPC

7. Examples of Negative Consumption Externalities Negative consumption externalities are spillover costs generated and received in the consumption of goods and services.

8. Reducing Externalities – The Use of Pollution Taxes One approach is to impose a tax . This is known as “making the polluter pay”. A pollution tax increases the marginal private cost causing a fall in demand Some economists argue that revenue from pollution taxes should be ‘ring-fenced’ and allocated to projects that protect or enhance the environment . For example , money raised from a congestion charge might be allocated towards improving mass transport services R evenue from higher taxes on cigarettes might be used to fund better health care programmes.

9. Reducing Externalities: Carbon Trading in the EU The EU Carbon Emissions Trading Scheme is cap -and-trade scheme for carbon dioxide It sets a decreasing cap for CO2 from energy intensive sectors, and allocates or auctions emissions allowances which can be traded on the open market. Businesses need to buy enough emissions allowances – the higher the price, the greater the incentive to cut pollution Aviation has just been included in the scheme The consensus is that a carbon allowance price of at least €30 a tonne is needed to drive investment in low or zero emission technology. But the EU carbon price has rarely reached this level. Indeed in recent years, an excess supply of permits has led to the market price of carbon permits collapsing to below €10 per tonne

10. Reducing Externalities: The UK Carbon Price Floor The UK has introduced a Carbon Price Floor which applies to fossil fuels used for electricity generation The minimum price for carbon emissions is designed to provide a stable carbon price signal as a way of internalising externalities The minimum Carbon Price Floor started at £16/tCO2 in 2013 In 2014 the UK government announced a cap of £18/tCO2 from 2016 until 2020 Carbon prices within the EU ETS system have been highly volatile in recent years Arguments for a carbon price floor Reduces the risks, and thus costs, of investing in low carbon projects Helps to reduce carbon price volatility – sends signal to polluters Makes low carbon electricity more competitive – boost to renewables Arguments against a carbon price floor Restrict supply of carbon permits to increase the free market price A carbon tax is a better alternative and raises useful tax revenues Price floor set high might damage international competitiveness

11. Advantages / Disadvantage of Pollution Taxes

12. Topical Examples of Externalities in Transport

13. Evaluation: Problems with Environmental Taxes Pollution taxes can lead to government failure: Assigning the right level of taxation : There are problems in setting the right tax so that private cost will exactly equate with the social cost Consumer welfare effects : Producers may pass on a tax to the consumers if the demand for the good is inelastic and, as result, the tax may only have a small effect in reducing demand. Taxes on some de-merit goods (for example cigarettes) may have a regressive effect on lower-income consumers and lead to a widening of inequalities in the distribution of income. Employment and investment consequences : If pollution taxes are raised in one country, producers may shift to countries with lower taxes. This will not reduce global pollution, and create problems such as structural unemployment and a loss of international competitiveness / worsening of the trade balance.

14. Cutting Emissions From C ars – EU Policies in Action

15. Progress in Cutting Emissions From Cars in the UK Average carbon dioxide emissions from new cars in the UK between 2004 and 2014 (in grams per kilometre )

16. Externalities and Government Regulations - Examples Health and Safety at Work Act covering all businesses. Renewables Obligation Certificates to encourage the supply of renewable energy (+ penalties for not meeting targets) Councils using by-laws preventing public consumption of alcohol. Consumer protection legislation e.g. against dangerous goods Laws such as the ban on smoking in public places from July 2007 The European Union has introduced directives on how durables such as cars, batteries, fridges freezers should be disposed of The EU also imposes increasingly tough rules on carbon emissions from vehicles which all EU manufacturers must meet Speed limits on roads and weight limits for lorries Quotas on how much fishing can take place in EU waters Bans on sale of certain substances / minimum age of legal sale Lowering alcohol limit for drivers – reduced by Scotland in 2014

17. Evaluating the Impact of Industry Regulations The case for regulating negative externalities Costs / disadvantages of adding extra regulation of industries Regulations act as a spur for business innovation e.g. to cut the level of carbon emissions High cost of enforcement / administration of laws / regulations Regulations may be more effective if demand is unresponsive to price changes Regulations can lead to unwelcome unintended consequences / Govt failure Regulations can be gradually toughened each year – this will help stimulate capital investment The c ost of meeting regulations can discourage small businesses and lower competition in markets

18. Negative Externalities EdExcel Economics 1.3.2