Negative production externalities lead to over production
The concept of externalities helps define situations that justify government
intervention and identify appropriate policy solutions to the problem. Externalities
exist when an individual’s actions impose costs on or provide
benefits to others who are not parties to the decision and who are neither
compensated for nor pay for the effects they receive. The result is that the
socially optimal amount of the good is not produced or consumed. Government
intervention can move the output closer to this desired level,
thereby improving the aggregate social welfare. This policy analysis perspective
also suggests the types of policies appropriate for addressing each
issue—marketable permits, taxes, or quantity regulations for negative externalities;
and subsidies, quantity regulations, or insurance against the worst
outcomes for positive externalities (Weimer and Vining, 2004). This approach
provides criteria for when government should act and the type of
policies it should use. However, it says nothing about why government acts
on some externality problems and not on others, or why it selects the specific
policy option it does from all those that would be appropriate. Nor does it
460 Social Science Quarterlyrecognize that most externality situations could be defined as either positive
or negative, depending on the type of action taken.