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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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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 ...

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.

See Also This Related BrainMass Solution

Article Review: "Big Businesses Have New Take on Warming"

Please read the article from WSJ "Big Businesses Have New Take on Warming" By JOHN J. FIALKA March 28, 2006; Page A4.
You can also locate the article down BELOW.

I need help answering the following questions:
1. According to this article, why will a voluntary approach likely fail?
2. What incentive does Wal-Mart have to make its stores greener while at the same time lobby government to enact legislation to regulate industry?
3. What is cap-and-trade approach? How is this an efficient approach?
4. Please give a real life example for negative externality and a possible solution to the negative externality.


Big Businesses Have New Take on Warming
Tuesday, March 28, 2006
(The Wall Street Journal)
By John J. Fialka

WASHINGTON -- The global warming debate on Capitol Hill is focused on whether the federal government should impose stricter emissions rules. But a key Senate panel is shifting the discussion from "whether" to "how."

The Senate Energy Committee is hearing from industry and activists about how a mandatory plan to control carbon dioxide and other so-called greenhouse gases could work. Many big businesses that resisted efforts to fight global warming are sending blueprints and companies like Southern Co. -- an Atlanta utility opposed to new controls -- have filed detailed proposals.

"We feel strongly that if there is going to be a mandatory program, it really has to be economy-wide," said Chris Hobson, a senior vice president at Southern. "To do it any other way would be unduly burdensome to our customers."

"What's interesting here is the diversity of companies and their willingness to respond in some detail," said Jonathan Pershing, a climate-change expert for the World Resources Institute, a nonprofit environmental think tank. Concern about the damage caused by climate change and industry's thirst for regulatory certainty, he predicts, could lead to passage of some form of mandatory carbon-dioxide controls within five years.

The energy committee has received 160 plans from companies and organizations, and members will hold a "roundtable" next Tuesday to sift through them. It will be Congress's first review of possible regulatory mechanisms of a system of mandatory controls.

President Bush has opposed anything other than a voluntary approach. Congress has debated and rejected climate-change regulation, but last fall the Senate opened the door a crack, with advocates mustering 53 votes for a resolution backing mandatory controls if they "will not significantly harm the United States economy."

The corporate proposals are part of an attempt to explore what is feasible along those lines. "There will be more good things put down by smart people on this effort than there have been at the beginnings of most processes like this," said Sen. Pete V. Domenici, (R., N.M.) chairman of the Senate panel.

One of the most ambitious plans comes from Arkansas retailer Wal-Mart Stores Inc., which last fall announced goals to make its stores greener. Andrew Ruben, Wal-Mart's vice president for corporate strategy, said the company wants the federal program to cover electricity generators, large industrial companies and the entire transportation sector. He said Wal-Mart won't wait for Congress to act and is planning a program to cut its emissions.

The company, which operates one of the nation's largest truck fleets, has set goals to make it 25% more efficient within two years and to double its fuel efficiency within 10 years.

Some of the most detailed plans are coming from utilities and other companies that would bear the economic brunt of new rules, including some who have lobbied against more regulations.

A number of major companies, including Southern and DuPont Co., favor what they call a "downstream" approach, which has an effect midway between fuel producers and the ultimate energy consumer. It would impose a cap-and-trade program for utilities and big manufacturers. The government would assign companies a "cap" -- a number of permits or credits to emit carbon dioxide -- which they could trade. Operators who emit less than their quota would have leftover credits to sell to those who need them to keep from exceeding their cap.

These companies also suggest that Congress add an "upstream" approach to cover the millions of cars and trucks in the transportation sector, which would be difficult to control driver-by-driver. So here the controls would shift up the chain of production, to oil refiners in the form of a higher fuel tax, or to auto makers, in the form of more stringent efficiency standards for new cars. The upstream approach would let market forces change consumer behavior.

"The U.S. could show a lot of leadership here because nobody else has figured out how to do this," said Richard Rosenzweig, chief operating officer of Natsource LLC, an emissions-trading firm in New York. He noted that ways to curb emissions in the transportation sector, which generates about 30% of the nation's carbon-dioxide emissions, will be needed in any program to lower U.S. emissions.

Duke Energy Corp., a Charlotte, N.C., electricity producer, is among companies suggesting that Congress apply the upstream approach to all economic sectors in the form of a tax on the carbon content of fuel. The approach would provide "price certainty, gradual timing and administrative simplicity," Duke's plan says. Under some forms of carbon tax, the government would use a portion of the income for research and development of cleaner energy sources and more efficient ways to use energy.

The American Iron and Steel Institute argues in its filing that neither the upstream nor downstream approach will work unless heavy energy users, such as steelmakers, get some form of relief from higher energy prices. Otherwise, they say, companies may shift production overseas. "Companies are very nervous about this," said Jim Schultz, a vice president of the institute. He said the price of carbon credits under the European Union's cap-and-trade system have climbed so high that European steelmakers are considering moving more production to countries such as Brazil, which doesn't have carbon-dioxide controls.

The Senate panel also is looking at systems being developed by Canada and Japan, both of which must comply with the Kyoto Protocol. That agreement among 38 industrial nations, not including the U.S., to reduce greenhouse-gas emissions went into force in February 2005, after Russia ratified it. The treaty requires most industrial nations to reduce emissions by an average of 5.2% below 1990 levels by 2012.

It isn't clear how the plans submitted to the Senate energy panel will compare with Kyoto's goals in reducing emissions. The blueprints U.S. lawmakers are considering focus more on the nuts-and-bolts of how the systems would work, rather than their precise effects in lowering greenhouse gases.

Japan will rely on voluntary emissions reductions at home and major government purchases of carbon credits from abroad to help Japanese companies meet their Kyoto targets.

Canada's system would cover about 10,000 plants in major industries, but, unlike Europe's, it has a "safety valve" that would allow the government to freeze the price of carbon-dioxide credits if market trading drives prices too high.

Some environmental groups argue the safety-valve approach will weaken mandatory controls. Jason Grumet, executive director of the bipartisan National Commission on Energy Policy, counters that it could be key to U.S. passage.

"With a safety valve you can go into a politician's office and assure him or her that the price will go no higher than X amount," said Mr. Grumet. Getting the U.S. to launch a program, he said, may be crucial to getting other big world emitters, such as China and India, to brave the political pain of mandatory controls. "You can't let the perfect become the enemy of the good."

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