Subsidies for Positive Externalities

Subsidies involves the government paying part of the cost to the firm to encourage more consumption, therefore supply shifts to the right.

Diagram of Subsidy on Positive Externality

• Subsidy = P2- P0
• The supply curve shifts to S2 and Price falls to P2
• People will now consume more at Q2
• Q1 = Social Efficiency: because SMC = SMB

Advantages of Subsidies

• a.) Increases social efficiency
  b.) Provides goods/services at a cheaper price

Disadvantages of Subsidies

• Is expensive and will require higher taxes.
• Difficult to estimate positive externality
• Giving subsidies to firms may encourage inefficiency, because the firms will rely on government aid.
• Govt Failure: The govt may have poor information about the service

Tax on Negative Externalities

1. Taxes On Negative Externalities

DISADVANTAGES of taxes

• Difficult to measure the level of negative externality e.g. what is the cost of pollution from a car?
• If Demand is inelastic then higher taxes will not reduce demand much
• Taxes will cause inequality
• Cost of administration
• Possibility of evasion. E.g. with tax on disposing of rubbish there has been anincrease in fly tipping (illegal Dumping of rubbish)
• May be difficult to decide who is causing pollution

Advantages of Taxes

• Provides incentives to reduce the negative externality such as pollution. E.g. cars have become more fuel efficient
• Social efficiency, 1st best solution.(where MSC = MSB)
• Taxes raise revenue for the govt. This can be spent on alternatives.

Externalities

http://www.bbc.co.uk/news/world-africa-16938914

Click on the above link to watch the video then answer the following questions:

a) State the negative externality and explain why it is a negative externality
b) What actions could the government take to reduce the negative externalities?