Externality and differences between the Pigovian and Cosian views Essay

Externality and differences between the Pigovian and Cosian views - Essay Example This paper discusses externalities and compares and contrasts Pigovian and Cosian Views. Externalities can cause inefficient allocation of resources, because when a negative externality is present, we produce and consume too much of the product and consequently, over-allocate resources to production. For example, when the fisherman is not aware of the effect of the fertilizers on his livelihood, he exerts more time and energy to catch fishes that has a dwindling population. His resources are inefficiently allocated. When a positive externality is present, we produce and consume too little of the product, which leads to under-allocation of resources to production. For instance, if there is a positive externality that involves one homeowner improving his property, other homeowners might not be motivated to improve their own properties. There is under-allocation of resources. Over-allocation and under-allocation of resources evidently result to inefficient allocation of resources. Furth ermore, the price system attains efficiency, if it rewards producers who can serve the customers well, mainly through providing the lowest possible prices (Baumol and Blinder 312). This system becomes faulty, when positive and negative externalities are not identified and integrated into the equation (Baumol and Blinder 312). There are diverse views on how to manage externalities. Some economists advocate for government intervention, while others want to rely on market mechanisms to correct externalities. When an externality causes the market to allocate resources inefficiently, the government can respond in one of two approaches: command-and-control policies or market-based policies (Mankiw 212). Command-and-control policies aim to regulate externalities directly by requiring or banning certain behaviors or actions (Mankiw 213). The government also uses subsidies to require positive behaviors that lead to positive externalities. Also, it is a crime to dump toxic wastes into the riv ers. The costs of pollution and adversities to health and livelihood greatly exceed the benefits to the polluter. Still, it is not always easy to control and monitor all negative externalities. For instance, every transportation vehicle produces some sort of externality or pollution by-products and it will not be feasible to eradicate or ban them all. As a result, the government creates government agencies that develop and implement policies that protect the environment, such as the Environmental Protection Agency (EPA) of the U.S. Other forms of government intervention that regulates externalities are market-based policies. They seek to align private incentives with social efficiency (Mankiw 213). For instance, the government can internalize externality by taxing activities that produce negative externalities, or it can subsidize activities that generate positive externalities (Mankiw 213). Taxes that internalize negative externalities are called corrective taxes (Mankiw 213). They are also called Pigovian taxes, after the economist, Arthur Pigou, who is one of the first advocates of such taxes. An ideal corrective tax would equal the external costs of activities that lead to negative externalities, while an ideal corrective subsidy would equal the external benefit of activities that produce positive externalities (Mankiw 213). This paper proceeds to explore the similarities between