Replacing the Polluter Pays Principle with the Cheapest Cost Avoider Principle
New Horizons in Law and Economics series
Chapter 2: The Pigovian Tradition and the Polluter Pays Principle
This chapter briefly describes the Pigovian tradition on which the PPP relies. First, the fundamental terms ‘market failure’ and ‘externalities’ are explained. Second, a graphical illustration of the working properties of a Pigovian tax is presented. 2.1 The Starting Point: Market Failure and Externalities Under certain very stringent conditions the competitive price mechanism leads to a Pareto optimal allocation of resources, that is, nobody can be made better off without at the same time making somebody else worse off. If these conditions are not met we have reasons to suspect an inefficiency of the market mechanism, or market failure. In this state of affairs market prices do not reflect marginal social costs or marginal social benefits, and profitability from an individual’s point of view does not necessarily reflect net social benefits. Externalities as a source of market failure play a crucial role in the analysis presented in this book. Externalities are unintended byproducts, spillovers of individual or firm behavior which can benefit or harm other parties (individuals or firms). If these effects on other economic agents are not reflected in the price a party has to pay for making certain decisions, the decision maker has no incentive to take the spillover into consideration – be it beneficial or detrimental to others. If the effect is detrimental (the externality is negative) the decision maker will choose an activity level that is higher than would be socially desirable. If the effect is beneficial (the externality is positive), then the decision maker’s activity level...
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