As we remember, two main parties that interact at the market while the good or service is sold are the buyer and the seller. However, sometimes there are other people that benefit or lose from the deal without participating in it directly. Such spillovers are called externalities because they are benefits or costs that accrue to some third party that is external to the market transaction. (McConnell, Brue & Flynn, 2012, p.104).
There are both positive and negative externalities and in our case we are considering the last ones since the local plant does not take into account the cost of breathing polluted air by local people. It shifts part of its costs onto the local residents as external costs and as a result, its marginal costs are lower than they would be if the plant had to pay for those costs.
There are two main groups of solutions that the government can use to make the offending producer pay:
- legislation which directly limits the activity of producers forcing them to incur the actual costs of the offending activity;
- specific taxes and charges which can be applied to related goods.
There is no general rule on what specific option should be used since the usage of the possible solutions by the government depends on the type of the production run by the company, the location of the firm, the peculiarities of the state law system etc.
References
McConnell C., Brue S., Flynn S. (2012). Microeconomics, 19th ed. Retrieved from: https://drive.google.com/file/d/0B7vAOBEILljQZmhjbHloRDRvX0k/view
