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Addressing Externalities: Negotiation, Adjudication, and Legislation

Explore the different approaches to reducing externalities - negative and positive spillover costs - through negotiation, adjudication, and legislation. Understand the importance of property rights and the challenges of radical change in addressing externalities. Discover the role of precedents and the potential for minimizing costs and maximizing fairness.

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Addressing Externalities: Negotiation, Adjudication, and Legislation

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  1. “The Economic Way of Thinking”11th Edition Chapter 12: Externalities and Conflicting Rights

  2. Chapter 12 Outline • Introduction • Externalities, Negative and Positive • Perfection is Unattainable • Negotiation • Reducing Externalities Through Adjudication • The Case of the Complaining Homeowner

  3. Chapter 12 Outline • The Importance of Precedents • The Problem of Radical Change • Reducing Externalities Through Legislation • Minimizing Costs • Another Approach: Taxing Emissions • Licenses to Pollute

  4. Chapter 12 Outline • Efficiency and Fairness • The Bubble Concept • Rights and the Social Problem of Pollution • Traffic Congestion as an Externality

  5. Introduction • Decision Making • Individuals choose their courses of action by weighing the expected marginal benefits of any decision against its expected marginal costs. • To affect the decision, benefits and costs for others must matter to the actor.

  6. Externalities, Negative and Positive • External Costs (spillover costs) • Negative externalities • Costs not considered in decision making. • Congestion caused by slow drivers creates extra travel time.

  7. Perfection Is Unattainable • Negative externalities cannot be completely eliminated. • Transaction costs • Are the costs of arranging contracts or transaction agreements between suppliers and demanders.

  8. Perfection is Unattainable • Scenario • Motorcycle rider leaves home early in the morning. • Imposes on neighbors still asleep. • Question • Why don’t they pay him to push his cycle out of the neighborhood prior to starting it?

  9. Perfection is Unattainable • Internalizing Externalities • When individuals take into account the externality when making a decision.

  10. Perfection is Unattainable • Industrialized Societies • Negative externalities multiply. • Civil people ignore negative externalities. • Must cultivate civic virtues. • Empathy • Courtesy • Humility • Tolerance

  11. Negotiation • Negotiation is used to minimize social problems created by negative externalities. • Negotiation produces mutual gains from exchange. • Failure to negotiate creates high costs to others.

  12. Negotiation • Clearly defined property rights provide the basis for negotiation.

  13. Reducing Externalities Through Adjudication • Adjudication • A process for deciding who has which rights. • Clarifies property rights. • Question • Which would happen if no one knew what to do or what to expect from others?

  14. The Case of the Complaining Homeowner • Person buys a house. • Airport is built nearby creating noise. • Should the owner be compensated for the costs created by the airplanes?

  15. The Case of the Complaining Homeowner • Questions • Would compensating one require compensating others? • Is this heavy cost on airlines and airports justifiable? • If we correct this one, do we correct all negative externalities?

  16. The Importance of Precedents • Compensation for Negative Externalities • Virtually impossible to do. • Expectations indicate property rights. • Court Decisions • There is no error when the decision creates the rights. • Error is possible when the decision seeks to discover the rights.

  17. The Importance of Precedents • Adjudication • Tries to avoid unexpected outcomes. • Tries to support expectations that are most widely and confidently held. • Tries to maintain a continuity of expectations.

  18. The Problem of Radical Change • Technology sometimes forces rapid changes. • New rules must be formed if negative externalities rapidly multiply. • Rising incomes have created changes in property rights. • Cost of pollution has changed.

  19. The Problem of Radical Change • We now place a high value on clean air. • Clean air as a right. • Requires new rules.

  20. Reducing Externalities Through Legislation • The creation of new rules is legislation. • Legislation clarifies property rights • Changing the rules of the game always raises the question of fairness and compels major changes in behavior.

  21. Reducing Externalities Through Legislation • The challenge for a society is to legislate • To avoid gross injustices • Minimize cost of achieving objectives

  22. Minimizing Cost • Minimizing cost isn’t the only consideration when government officials are trying to achieve some objective. • Fairness is also a criterion for the evaluation of government decisions.

  23. Another Approach: Taxing Emissions • It is difficult at times for government agencies to determine unit cost. • Polluters have an incentive to exaggerate their costs. • To resolve this kind of information scarcity in the least costly manner, the EPA could impose a tax per unit of emissions.

  24. Another Approach: Taxing Emissions • Pollution is a spillover cost, a cost not borne by its producer. • If the per unit cost of a pollutant is set equal to the spillover cost per unit, then the creator of the costs is made to bear them. • With the tax, less pollution will occur. • Question • At what point would pollution cease?

  25. Another Approach: Taxing Emissions The task of the EPA is to compare the marginal cost of reducing the emissions with the marginal benefits.

  26. License to Pollute • Most pollution is: • A cost. • Not a crime. • Pollution tax becomes a • License to pollute.

  27. Efficiency and Fairness • Some people object to taxes on pollutants because they regard such taxes as unfair. • They supposedly place the whole burden of the tax on the poor, while allowing the rich to go on fouling the environment. • It must be shown that the efficient solution can be achieved while settling the fairness issue in different ways.

  28. Efficiency and Fairness • Some people • Object to pollution taxes as unfair • Tax burden to the poor • Allow the rich to foul the environment. • An efficient and fair solution is achievable. • The tax approach is • In general superior vs. physical restrictions.

  29. Bubble Effect Concept • A giant bubble exists over the whole firm • Control total emissions into the bubble. • Under this policy firms • Allow emissions to rise if control is costly. • Making up where control is less costly. • Environmentalists – no one owned the right to pollute.

  30. Rights and Social Problem of Pollution • Pollution • A major social and political concern. • People disagree about rights. • Demand for any good • Never completely inelastic. • Including clean air. • Control should be avoided • People should choose pollution reduction which lowers costs to themselves.

  31. Traffic Congestion as an Externality • Traffic congestion • Negative externality • Cost generated when ignored in decision process • Only recognize cost others create • If motorists had to pay • Marginal congestion cost • Drive when benefits exceeded costs

  32. Traffic Congestion as an Externality • How can externalities be internalized? • Pricing (for congestion) • Tolls • Gasoline Taxes • Road construction • Not for use

  33. Once Over Lightly • Spillover Costs – from people’s actions. • Spillover Costs = Externalities • Transaction Costs prevent negotiations. • Negotiation used to secure cooperation. • Clearly defined property rights ease negotiations. • Some pollution reduction activity is more efficient than others.

  34. End of Chapter 12 QUESTIONS?

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