ECONOMY PUBLIC

Externality- Task 2
By : Ria Amalia / 021100032

TRISAKTI UNIVERSITY 3/15/2012

THE CONCEPT OF EXTERNALITY

DEFINITION OF EXTERNALITY In a modern economy, every activity is linked with other activities. If all the links between an activity with other activities implemented through market mechanisms or through a system, the linkages between these activities not cause a problem. However, there are many linkages between the activities that are not through the market mechanism causing various problems. Linkage of an activity with another activity that is not through the market mechanism called the externality. In general can be said that the externality is an side effect from an certain act of one side to another side and more specifically, externalities occur when production or consumption activities of one side affect the utility of other affected parties, whether the advantage or disadvantage effects. Side effects from an economic activity or transaction can be positive (positive external effects, external economic, benefit) or negative (negative external effects, external diseconomic, cost). In fact, both negative and positive effects can occur concurrently and simultaneously. for example, someone who built something beautiful views and nice at a particular location has a positive impact on people around the passes that location. While the negative impacts such as air pollution, water and noise.

POSITIVE EXTERNALITY

NEGATIVE EXTERNALITY

There are also externalities known as a pecuniary externalities which emerged when the impact of externalities that are caused by increase in prices (the price changes of some input and outputs), in other words, this externality occurs when a person economic activity affecting the financial condition to

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others side . for example: increased sales of furniture will lead to increased wood prices which will then affect the purchasing power of consumers and the welfare of construction materials or other consumers who utilize the wood. So the externality is when actions of a person have an impact to other people without any compensation so that the resulting inefficiencies in the allocation of production factors.

TYPES OF EXTERNALITIES Efficiency of resource allocation and distribution of consumption in a market economy with free competition and perfect can be disrupted, if the activities and actions of individual economic agents both producers and consumers have an impact (externality) both to themselves and to the other side. Externalities that may occur from these four economic interaction (Pearee and Nash, 1991; Bohm, 1991): 1. Effect or impact of the producers to other producers Production activities have an external impact to other producers if the activity that resulted in a change or shift the production function from other producers. Impact or effect in this category include the cost of purification or cleaning of water used (eater intake clenup costs) by downstream producers are facing water polution caused by upstream producers. This occurs when downstream producers need clean water to production

process. example: A process of production (eg pulp), produce waste residues, waste products are toxic and into the river, lakes, so that fish production is disrupted and finally detrimental to other producers that the fishermen. In this case, the pulp production activities have a negative impact to other production (fish) or fishermen, and this is the effect of a production activity to the production of other commodities.

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2. Effects or side effects of production activities to consumer (effects of producers on consumers) A producers has external effects to consumers, if the activity change or shift the utility function of household (consumer). include noise pollution (noise), reduced the attractiveness of natural amenities for mining, the danger of radiation from the generating station (air pollution) and water pollution, all of which affecting the consumers or the public convenience. In this case, an economic agent (firm-producers) that produce waste into the air or affects the flow of rivers and other agents that utilize natural resources in various forms. For example, customer satisfaction to the utilization of recreational areas will be reduced by the presence of air pollution. 3. Effect or impact of a consumer to another consumer The impact from consumer to other consumers occurs when a person or group activity affects or disrupt other consumer utility function. An individual consumer can be influenced not only by the side effects from production activities but also by the consumption by another individual. Impact or effect from an activity of a consumer to another can occur in various forms. For example, the noise of a neighbor's lawn mower, the sound of radio or music noise from neighbors, etc. 4. Effect of a consumer to producers The impact from consumer to producers occurs if the consumer activity disrupt the production function of a certain producers or producer group. for example occurs when household waste discharged into the river and contaminating so that disturb certain companies that utilize the water like a fish (fishermen) or companies that utilize clean water. Baumol and Oates (1975) explains the concept of externalities in two different senses:

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1. Externalities that can be discharged (a deplatable externality) is an external impacts that have private good characteristics which if consumed by an individual item, the item can not be consumed by others. 2. Externalities that are not empty (udeplatable an externality) is an external effect that has characteristics of public goods which the goods can be consumed by someone, and also for others. In other words, the amount of a person to consume the goods will not reduce the consumption of others. THE FACTORS THAT CAUSE OF EXTERNALITY Externality occur basically because of human activities that are not follow the economic principles environmentally sustainable. In economy view, externalities and inefficiencies occur because one or more from the principles of efficient allocation of resources are not fulfilled. Characteristics of goods or public resources, market imperfections, government failure is situations in which the elements of the right of ownership or exploitation of resources (property rights) is not fulfilled. if all these factors are not handled properly, so the externalities and inefficiencies can not be avoided. If this is allowed, then it will give unprofitable impact on the economy, especially in the long run.

1. The existence of public goods

Public goods are goods that when consumed by a particular individual would not reduce the consumption of others. There are two main characteristics of public goods. First, this is a general consumer goods that are characterized by joint supply and non-rivalry in consumption. Second characteristic is not exclusive its mean that the supply is not only for the person and neglect the others. Public goods related to the environment include fresh air, beautiful scenery, recreation, clean water, comfortable living and etc. Mechanism which differentiates is by setting the price (monetary value) of public goods that will be private goods and the benefits become earned from the prices that can be used to control or improve the quality of the environment itself. But the pricing decision is becoming a problem in the analysis of environmental economics. Due to its characteristics, public goods are traded so it does not have a price, public goods are used excessively and not have an incentive

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to conserve. All people or the consumer does not care to determine the true price of public goods. In this case, prompting some people as a "free rider". For example, if the Person A knows that the goods will be provided by the B, so the Person A did not want to pay for the supply of goods with the hope that the item will be provided by the B. If person B finally decided to provide the goods, so the Person A can join to enjoy it because no one could prevent to consume the goods, because of the characteristic of public goods that are not exclusive and is a general consumption. This situation is finally tends to result in reduced incentives or stimulus to contribute to the provision and management of public goods. If there is any contribution, the contribution is not large enough to finance the provision of public goods is efficient, because people tend to give lower value than expected (undervalued).

2. Common resources
The existence of common resources or open access on a particular resource is not much different from the existence of public goods. Sources of the common resources, as well as public goods, not exclusive. These resources are open to anyone who wants to use it, and for free of charge. But unlike public goods, the common resources have a rival goods. Use by someone, would reduce the opportunities for others to do the same thing. Thus, the existence of common resource, the government also needs to consider how much the efficient utilization. To solve this problem, the government can implement regulations or enforce tax . Alternatively, the government can change the the common resources into private goods.

3. Market imperfections
Environmental problems can also occur when one participant in an exchange of property rights (property rights) can affect the results that occur (outcomes). This can happen in an imperfect market as in the case of monopoly (single seller). These market imperfections such as occurs in practice of monopolies and cartels. Concrete examples of practice of this cartel is the Organization of Petroleum Exporting Countries (OPEC) by produce in smaller amounts so that the resulting increase in prices that are higher than normal. Such conditions will only cause the increase in the producer surplus value is much smaller than the loss of consumer surplus, so that overall, this monopolistic practices detrimental to the public (worse-off).

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4. Government failure Sources of inefficiency and or externalities are not only caused by market failure but also because of government failure. Failure of government governments caused the interest pull of the government's own or groups (interest groups) that does not encourage efficiency. This particular group of governments to exploit for profit seeking through the political process, through the policies and etc. Profit-seeking actions can be in various forms: Groups who have particular (interest groups) to lobby and other efforts that allow the implementation of the rules to protect and benefit them Practices can also profit from the government itself legally impose such excessive protection for certain items such as high import taxes by reason of increasing the efficiency of domestic firms. EXTERNALITY IN PRODUCTION Appropriate taxation is said to be able to create the internalizing an externality, because these taxes give consumers and producers an incentive to take into account the external effects of their actions. Producers will be encouraged to calculate the cost of pollution prevention as part of production costs, before they decide the quantity of goods they will produce ( the meaning they are also trying to limit the pollution caused by the production process, because they have to pay tax on any pollution that are not controlled). Although many markets where the social costs of production exceed private costs, there are also markets quite the opposite, the personal costs of the producers even greater than the social cost. In this market, externalities are positive, meaning that the benefit (other than the producers and consumers).

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EXTERNALITY IN CONSUMPTION So far, the externalities that was discussed only the externalities relating to the production activities. In addition there contains externalities in consumption activities. Consumption of alcoholic beverages, for example, contains a negative externality if the drinker then drive the car in a condition consciousness or half drunk, thus endangering other road users. Externalities in consumption is also there that are positive. An example is the consumption of education. More and more people are educated, the people or the government will be benefited. The Government will be easier to recruit qualified personnel, so that governments is more able to function in servicing the community.

POSITIVE EXTERNALITY

THE PRIVATE SOLUTION TO OVERCOMING THE EXTERNALITY I. PRIVATE SOLUTION Market inefficiencies due to externalities or not should always be addressed by enforcement or improvement of moral standards, or the threat of social sanctions. Private markets are also sometimes able to overcome the problem of externalities, by allowing the parties concerned to overcome them. Their main motive is to meet its own interests, but in doing an act, they also simultaneously address the externalities. For example, let's see what will be done by an apple farmer and a beekeeper who lives nearby. At the time the bees seek honey from flower to flower more apples, bees to pollinate and accelerate the apple trees to bear fruit. This benefits the apple farmer. While the farmers are also lucky

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because he does not need to feed the bees. But if mutual partnership is not taken into account, then both sides can lose. If an apple tree planted by the farmer is too little, then the bees will be food shortages. Conversely, if the bees are kept the farmers too little, then the process of pollination is not smooth. These externalities can be internalized by the combined efforts. The other way in the private market in overcoming externalities is, preparing a contract or agreement between the parties that put the interests. In the example above, the apple growers and beekeepers can make the partnership agreement, so that each can provide an optimal positive externalities, negative externalities as well as eliminating the (number of trees or the number of bees is too small). In the agreement could be arranged, how many trees must be planted the farmer, and how many bees that have maintained the breeder. If the costs are borne by the two are not equal, then it could be arranged who should pay whom, and how much. Through these contracts, the possibility of inefficiencies that come over from the negative externalities can be avoided, and both parties will be equally better off than if they run their business on their own, without taking into account the interests of other parties.

II.

COASE THEOREMA Coase theorem is derived from the theoretical economist named Ronald Coase, who stated that

the solution can be very effective if the private sector fulfilling the requirements. The requirement that are interested parties may negotiate or negotiate mitigation measures externality problems that exist between them, without incurring the a burdensome special allocation of existing resources. According to the Coase theorem, only if the condition is met, then the private sector will be able to overcome the problem of externalities and increasing the efficiency of resource allocation.

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Thus, it can be concluded that: the Coase theorem states that private economic agents , can solve its own problem of externalities that arise between them. Regardless of the distribution right at first, interested parties are always likely to reach an agreement that benefits all parties, and is an efficient solution.

PUBLIC POLICY TO OVERCOME EXTERNALITIES

Each time the externalities arise that result in the allocation of resources to do a market is inefficient, the government in one of two choices of action available. The first option is to implement the policies or approach to command and control (command-and-control policies), or implement policies based on the approach to the market (market-base policies). For the economist, the second option is better, because market-based policy approach will encourage decision makers in the private market, to voluntarily choose to overcome their own problems.

A. REGULATIONS The government can overcome the externalities by prohibiting or requiring certain conduct of certain parties. For instance, to overcome the habit of toxic waste into the river, a far greater social costs than benefits those who do, the government can declare it as a criminal act and will judge and punish perpetrators. In this case the government is using regulation or command and control approach to eliminate externalities earlier.

B. PIGOVIAN TAX AND SUBSIDIES In addition to implementing regulations, to overcome the externalities, the government can also implement policies that are based on a market approach, which may combine

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personal incentives / private sector with social efficiency. For example, the government can internalize the externalities of the use tax on activities that give rise to negative externalities, and instead provide subsidies for activities that gave rise to positive externalities. Special tax is applied to correct for the effects of a negative externality commonly referred to as a Pigovian tax.

C. POLLUTION PERMITS OF MERCHANTABILITY Right to voluntarily transfer pollution from one company to another company. Pollution rights trading market will further grow and develop, and in turn, will be subject to market forces of supply and demand. The companies are faced with a very high cost for pollution, it would be an active market, because for them, bought the rights to pollute less expensive than making new investments to reduce pollution their factories. Instead, companies are not faced with severe constraints to reduce pollution, would be happy to sell their rights because it would pollute the income meberinya Free of Charge.

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CONCLUSION

So the externality is when actions of a person have an impact to other people without any compensation so that the resulting inefficiencies in the allocation of production factors. There are any four types of externality; Effect or impact of the producers to other producers, producer to consumer, consumer to consumer and consumer to production. There are the factors that cause the externality; The existence of public goods, common resources, Market imperfections, market failure. Although the reduction in pollution through the implementation of pollution permits seem to differ from the case of application of the Pigovian tax, the real impact of the end of the policy will be the same. In both cases, the company still must pay for pollution they cause. In the case of Pigovian tax, the polluter pays corporate taxes to the government or some kind of penalty, the pollution they cause, the economists also believe that the application of Pigovian taxes, is the best way to reduce pollution. While in the case of pollution permits, companies must buy permits from the government. (Even companies that already have pollution permits still have to pay in another form, namely the opportunity cost of polluting form of revenue they would get if they sell pollution permits in an open market). Thus, the application of Pigovian taxes or pollution permits, both to internalize externalities, by forcing the company to bear certain costs for polluting. And the approach command and control (regulation) will not give a reason or incentive for factories to try to overcome the polluter pollution as much as possible.

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