Regulation of activities that cause negative externalities

?

Regulation of activities that cause negative externalities

Advantages

  • Negative externalities have a negative impact on a third party that is not the consumer or the supplier. The free market disregards social costs of a particular good or service, which might lead to an allocation of resources further away from the social optimum which is why regulation, to ensure social welfare is needed.
  • Regulation may be more effective if the demand is unresponsive to changes
  • Regulations can be gradually toughened each year- stimulating capital investment

Disadvantages

  • High costs of enforcement and weak penalties can make regulation ineffective
  • Law of unintended concequences +government failure
  • Costs of regulation can discourage small businesses from startingup- increasing barriers of entry leading to a loss of competition

Evaluation

Regulation would shift the private cost curve to the left, bringing it closer to the social optimum, and hence correcting the market failure (assuming that there is not a lack of competition in the market; the shift of the supply curve to the left may encourage the chances of imperfect competition which is another cause of market failure). This may only be effective in the short run, as firms may find other ways to trade their goods and services, therefore just regulation may not be enough to deter firms from generating negative externalities. 

Comments

No comments have yet been made