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Discuss whether regulation is the most effective way of correcting market failure such as those
arising from increasing carbon emission.
Market failure is when the free market fails to provide an efficient allocation of resources. A demerit good
is one which is over consumed and over produced since consumers do not perceive the true cost of the
good. These bring negative externalities. Negative externalities are the cost to third parties, of production
and consumption decisions. In the free market, more than the socially optimum level of demerit goods is
produced. Unfortunately this can never be completely eradicated due to things such as the black market.
But what governments can do is regulate demerit goods, such as those that increase carbon emissions.
A form of regulation is indirect taxation. An indirect tax will internalise the costs. The government can place
this tax on producers, which will increase their costs of production. This can be a tax placed on the use of air
travel or cars. The tax should ideally be the same as the size of the external cost associated with good, in
order to avoid accusations of 'fat cats' and the government simply attaining money for the sake of it.
Indirect taxation will push the supply curve backwards, increasing the cost of the product to the consumer
and reducing the quantity made, however, it is a key way in reducing the carbon emissions and therefore
the negative externality itself. The new price of the good reflects the true cost to society and will be
contract demand; and effective way of reducing the consumption of the product that increases carbon
emissions. Furthermore, indirect taxes generate revenue for the government. The amount of the revenue
depends of the elasticity of the product: if the product is hugely elastic, the revenue for the government
will be less as more people are put off by the raised price. But if the product is highly inelastic, then the
government will receive more revenue as people will still buy the product despite the raised price. In the
current economic climate, government revenue is a valued commodity. It could be used to invest in an
alternative to the carbon emitting products, or to raise awareness of the costs of pollution to society. It
seems that indirect taxation benefits everyone, or at least to some degree. Even so, there are some
negative points about it.
One of the problems with using indirect taxes to solve this market failure in particular is that it will be
difficult for the government to get the size of the tax right. It's also almost impossible to place a monetary
value on the external costs. Because carbon emissions are produced from a wide variety of things it would
be very difficult to tax the right output with the right amount. Too smaller tax will be ineffective whilst too
larger tax will reduce consumption creating a loss for the company. Also, taxation is only effective on very
specific products. For example, a tax on air travel may depend on the economic climate as well as if there
are any substitutes. But because flying is the fastest means of transport, consumers might be willing to pay
the extra cost imposed by taxation and carbon emissions will remain the same: indirect taxation, in this
circumstance, may not be the best option.
An alternative method to indirect taxation is using pollution permits. This is a permit that allows the owner,
in this case a firm, to emit a certain amount of pollution. Furthermore, if the permit is unused or partially
used it can be sold to another polluter. Pollution permits are a viable alternative to indirect taxation because
firms who pollute more will have to buy more permits and so pay for their pollution which might encourage
them to become greener. This way the amount of carbon emissions can be reduced. However, the
effectiveness of this policy is highly dependent on firms: if a firm is rich, they can buy the permits without it
affecting their revenue, meaning they will feel that it is okay to pollute and their pollution will not be
reduced, simply limited. This is a crucial point because it means that firms will not realise the true costs and
so they will continue to produce goods which create carbon emissions. Furthermore, it is very difficult to
decide what the limit should be and so it could take a long time to reach a conclusive decision. Pollution
permits will only work if they are carefully planned, and firms are encouraged to go greener. On balance, in
reducing carbon emission, I think pollution permits are the best option. Due to elasticity of the products
which produce carbon emissions (fuel, air travel, vehicles) an indirect tax wouldn't affect demand and
therefore pollution would still continue as demand would not fall. All that would happen is that the
government would receive slightly more revenue but they would have failed to correct the market failure.
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Nothing will eliminate carbon emissions; they are a bi-product of necessary goods. But pollution permits
would be the most effective way to limit the negative externatility they produce and correct market failure.…read more