Government Intervention: Fines, Regulation & Permits (Edexcel IGCSE Economics)

Fines and Regulations

• Regulation is the process of monitoring and enforcing laws aimed at limiting the harm caused by the external costs of consumption or production

• Reasons for regulation include preventing exploitation of consumers, taking externalities into account, and reducing consumption of negative externality goods and services

  • E.g. In August 2017, Kenya implemented one of the world's strictest bans on plastic bags, prohibiting the manufacture, sale, and use of plastic bags in the country. This ban aims to mitigate the environmental damage caused by plastic bags, including visual pollution 

• Regulatory agencies are often created to enforce the law and ensure that they are not broken

  • Examples of regulators in the USA include The Environment Agency, The Food and Drug Administration (FDA), and The State Bank Regulators

• A fine is a monetary penalty for breaking laws or regulations

  • E.g. A fine of $15 billion in USA was imposed on Volkswagen after the Dieselgate scandal

    • Regulators penalised VW for attempting to cheat emission tests and causing external costs to the environment

Evaluating the use of regulation and fines

Pollution Permits

• Governments calculate an optimum (or preferable) level of pollution that is acceptable in society

• Governments issue permits to polluting firms and then create a market where these firms can for buy and sell their pollution permits

  • Each permit allows a firm to pollute up to a certain amount. Any surplus can be sold for additional revenue

  • Heavy-polluting firms have to buy additional permits from less-polluting firms

  • The price of the permit is determined by demand and supply

Diagram: The pollution permit market

• The cost of the permit becomes an additional cost of production, which should reduce supply and therefore bring output closer to the socially optimal level

• If the price of additional permits is more than the cost of investing in new pollution technology, firms will be incentivised to switch to cleaner technology

• If the system works effectively, it can correct air pollution and therefore reduce the associated negative externalities

• E.g. Germany is one of the top emitters of air pollutants in Europe. Most air pollution comes from the industrial sector, including power plants and manufacturing facilities. Germany uses pollution permits as part of the European Emissions Trading System (ETS)

An evaluation of pollution permits