Internalizing Negative Externalities: Taxation as a Solution

The content discusses the negative externalities of dairy products, such as the overproduction of milk and its impact on animal welfare. The government can employ various policy initiatives to address these concerns, including taxation, quota setting, and regulation. These policies aim to internalize the negative externality by increasing the private cost for producers. However, they also have potential drawbacks like adding deadweight loss or government failure. On the other hand, as private individuals, we can apply Coase Theorem to reduce externalities, increase product quality, and breed dairy cows efficiently. Additionally, we can promote animal welfare by not indulging in unethical practices like slaughtering bobby calves. While these solutions have their limitations, they offer alternative approaches to addressing the concerns surrounding dairy production.

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Q1. The article calls for public policy initiatives to address animal welfare and
environmental concerns associated with dairy farming. With reference to economic
concepts covered in this course, explain why the government might want to intervene in the
dairy market.
Answer
The dairy farming in Australia is going through the crisis. The dairy products are cheap, and
there are a lot of fluctuations that are happening in the markets on both domestic and global
front. The farmers are facing financial problems due to this. Also, the dairy cows are being
exploited, and the environment is getting adversely affected. So, it is necessary for public policy
initiatives to address animal welfare and environmental concerns associated with dairy farming.
It is depicted in the article that the self-interest of the industrialists in dairy farming is producing
inefficient results. For example, it is written in the article that the industrialist is making the
dairy cows subject to the continuous cycle of impregnation, and are artificially inducing calving
and milking for increasing their productivity. Thus, this is the scenario of market failure as here
the allocation of goods and services are not efficient enough for the dairy activities (Harvey,
2013). Improvement is required in this scenario for the betterment of the society. Thus, the
government needs to intervene in this.
There are different types of goods in the economy. Common goods or common resources are
those that are rival, but they are not excludable. Public goods are those that are neither
excludable nor rival (Betz, 2014). The dairy farm is a common resource because it has all the
characteristics of the common resource, i.e. it is rival but non-excludable. Rivalry means that
when the dairy farm is used by one consumer or person, its availability or usability for other
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people and consumers declines. For example, the cow has produced milk and a consumer comes
and consumes the milk, so he has declined the availability of the cow’s milk for other consumers.
Non-excludable means that the consumers cannot be prevented from making use of the dairy
farm (Betz, 2014). Hence, it is a common resource. So, a government needs to intervene because
if the resource can be used by anyone, so it will get destroyed, and people will make unethical
use of it. With government interference, the resource use could be regulated, and it could be
used properly.
The process of animal welfare is a negative externality. Negative externality means that the
economic transaction’s cost is borne by a third party (Henderson, 2014). The third parties are the
people, companies, owners', etc. who are affected indirectly. In the article, it is mentioned that
due to the livestock farming, the climate is getting affected so the people who live in that climate
are the third parties, and they suffer due to this negative externality. Therefore, if the government
intervenes in the dairy farming activities, it could reduce this negative externality by making
laws, policies or rules in which the third parties are protected from getting affected by the
activities of farming and dairy.
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Q2. A tax on dairy products is one public policy initiative the government might consider.
Perform appropriate economic analysis to explain how a tax could be used to address the
animal welfare and environmental concerns raised in the article. Discuss the pros and cons
of using such a tax as a policy initiative.
Answer
In the above diagram it is depicted that the demand and supply of dairy products were happening
at Qm. When the government imposed the tax on the dairy products, the price got increased, and
the quantity demanded fell to Qo. The social cost, private costs, is also depicted in the image
above. Thus it is clear from the diagram that by levying a tax on the dairy products, the
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government is trying to discourage the demand and supply of these products. When they are
demanded in less quantity, the producers will not indulge in unfair means of increasing the
productivity.
It can be analyzed from the diagram that the market output is larger than the social optimal
output because when buyers and sellers make decisions they only consider private cost and
benefits it is not socially optimal because they ignore externality. Also, when tax is same as the
externality, then private cost becomes social costs. This is because the extra amount will not be
put by the government and the graph will not move in the upward direction. Since a private cost
is equal to the social cost, then the market output becomes social optimal output. This is due to
the same reason that there will not be any movement in the supply curve. Therefore, tax
internalizes the negative externality for the producers and consumers.
These products have negative externalities as described in question 1. These results in market
failure because the producers and the industrialist do not take into account the costs that are
borne by other people due to the production of these products (Henderson, 2014). When the
buying and selling decisions are made by the producers and consumers in the market, they do not
think about the externalities; they are just concerned about the private costs. So, by levying a tax,
the government has tried to increase this private cost so that it becomes a consideration for the
buyers and sellers and indirectly, the government is trying to remove the negative externalities.
As shown in the diagram, when the tax is added to the private cost, it increases up to the level of
social cost (Tietenberg, 2016). So, the government has changed this private cost to social cost.
Even if the production is happening in a bad way now, the government as resources to rectify it
and secondly, with more cost to the producers, the production will automatically reduce. Since
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private cost becomes the social cost, the market output has become social optimal output. The
tax has internalized the negative externality for the producers and consumers.
Such tax policy has cons like it do not add deadweight loss; it is not necessary that the
government intervention can solve problems but make it a loss, and then it becomes a
government failure; the government does not have perfect information. But the pros of Such tax
policy is that it gives rise to tax revenue.
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Q3. What other public policy initiatives can the government employ to address these
concerns? Discuss the pros and cons of these.
Answer
The other public policy initiatives that the government can employ to address these concerns are:
1. The government can regulate the production of the dairy products by limiting the number
or liters of the products produced. It can set a quota for the production of such products
(Bös, 2015). This policy initiative will help in regulating the production, and the
producers will not indulge in the unfair mean of production to increase the productivity
from dairy cows and the bobby's calves. But, due to the fixing of quota, the supply may
fall short of demand, and also there will be an adverse impact on the exports of these
products.
2. The government can fix rules regarding the productivity, breeding of cows, their
impregnation, etc. the government should also follow up on these rules by appointing
authority to look at the rules and its following in a proper way (Bös, 2015). The non-
followers should be penalized and their license to carry such activities should be canceled
by the government. This policy will reduce the unfair practices of producers, but it will
put an extra burden on the government as it will have to bear the cost of regulation and it
will have to spend extra time on these activities.
3. The government should set up inspection teams that will go and observe the practices of
production at the dairy farms and the industries. The inspection team should be given the
authority to do surprise visitors, cancel the license if they observe unethical practices and
penalize the producers. This policy will also reduce the unfair practices of producers but
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it will put an extra burden on the government as it will have to bear the cost of regulation
and the inspectors will have to spend extra time on these activities.
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Q4. What can we as private individuals do to address these concerns, in the absence of
government intervention? Are such private solutions likely to be effective?
Answer
We as private individuals can do the following things to address these concerns, in the absence
of government intervention:
1. We can apply Coase Theorem to help in reducing the concerns. The market is
competitive here and the transaction costs are also nil. When the transaction costs are
absent and he output and the inputs from the production-optimal distribution are selected,
regardless of how property rights are divided. Thus, this will help in distributing the
benefits of the products to all people in an optimal manner and the allocation of the
dairy output will happen efficiently even in the presence of externalities.
2. We can increase the quality of the products as well the productivity of the dairy cows by
giving them proper care in the form of proper feeding of the animals, letting them graze
on the productive lands where they are eating the grass and not the soil. We can also
breed the cows and give them proper care so that they give good quality milk. This
solution is effective because it is not harming the animals or the environment. But, this
solution requires time and patience of the producers.
3. We can also reduce the wastages by not indulging in the slaughtering of the bobby calves
and other animals. They should not be injected unethically. This will protect the animals
and their breed.
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But there is a question on the effectiveness of these solutions because the parties that get affected
by the externality try to bargain so that they are able to reach an outcome which is more efficient
for them. For example, if the demand for the products increases and the productivity is less, the
private individuals will start to restore to unethical ways of increasing the productivity from the
animals. So, the economic players are self-centered hence private solutions do not tend to last
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References:
Australia, D., 2014. Australian Dairy Industry. Dairy Australia. Available online: www.
dairyaustralia. com. au/Industry-information/About-the-industry. aspx.
Betz, F., 2014. Public Good and Private Good. In Why Bank Panics Matter(pp. 121-134).
Springer International Publishing.
Bös, D., 2015. Pricing and price regulation: an economic theory for public enterprises and
public utilities (Vol. 34). Elsevier.
Harvey, D. and Hubbard, C., 2013. Reconsidering the political economy of farm animal welfare:
An anatomy of market failure. Food Policy, 38, pp.105-114.
Henderson, J.V., 2014. Economic theory and the cities. Academic Press.
Tietenberg, T.H. and Lewis, L., 2016. Environmental and natural resource economics.
Routledge.
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