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How a Government Handles Externalities

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Discuss the various ways governments can handle externalities, such as noise from a local airport or a barking dog or building of commercial office space or an industrial building in a residential area? How does the assignment of property rights affect the outcome? Under what circumstances would a socially optimal solution arise without any government intervention? Under what circumstances would government intervention likely move the outcome closer to a socially optimal solution?

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Solution Summary

This answer tackles the issue of externalities, including the economic rationale behind the concept and the various policy prescriptions that may mitigate the difficulties.

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Hi,
This is basic economics and a theory found in most neoclassical textbooks - the theory of externalities. Basically, that an activity creates consequences external to the actor that is undertaking the activity, for which he/she doesn't see the consequence. The textbook examples often include pollution or, as in your question, noise/clutter. Theoretically, this is expressed as the social cost of the activity being greater than the individual's cost - and the way that these two costs can be put in line is via government intervention. In this way, government can increase the cost ...

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