The Government’s Job :
Although there are several ways in which individuals can reduce the effects of
externalities, sometimes you’ve just got to let the government handle it (it is one
of the 10 Principles of Economics after all)! There are two ways in which
governments can combat the inef?cient allocation of resources as a result of
externalities : market-based policies and command-and-control policies. Let us
explore both of these in a little more detail.
Command-and-control policies involve the government directly regulating
behavior. They determine the activity which is resulting in negative externalities
and either completely prohibit it or limit the amount of time that can be spent
engaging in the said activity. Market-based policies, in comparison, involve the
use of Pigovian taxes to counteract the effects of negative externalities.
Economists generally favour market-based policies over command-and-control
policies as it gives businesses and individuals an active incentive to reduce their
negative externalities. If they must pay a tax on a particular action then they will
attempt to reduce the amount of time they engage in that action in order to save
money. However, if the government implemented a command-and-control
policy on that action, the business or individual would not attempt to lower the
amount of time they spend on the action below the allowed amount as doing so
would not save them any more money.
Conclusion :
In conclusion, externalities are really a lot more simple than you initially
thought. Whether positive or negative, it is clear that they have a large impact
on the ef?cient allocation of resources in society. However, this impact can be
manipulated by both the public and the government in order to either increase
or decrease the effect of the externality in question.
Reference : Mankiw, N. Gregory, and Taylor, Mark P., ?Economics : Second Edition?, South-Western
Cengage Learning