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Moreover, since cleaning up the river would cost money, the company can sell its paper products more cheaply than if it had to absorb such pollution control costs. As a result, the paper company can further increase its output, responding to the relatively higher demand at its lower prices, leading to more waste and pollution from its factory. By polluting without penalties, the company may also have an unfair advantage over competitors whose paper products do reflect the cost of installing pollution control equipment.

This is a classic example off so called external cost that is not reflected in the price through normal workings of the marketplace. Neither the paper company nor its customers are bearing the actual cost of paper production; instead, a portion of the cost, the pollution factor has been shifted to the people who live or work along the river and those taxpayers who eventually are stuck with the cleanup bill. Like other externalities, pollution often occurs where the ownership of a resource, in this case the river is not held by individuals or private organizations.

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Public lands and roadsides, for example, are more often littered than the lawns in front of people’s homes, because no one person owns these public lands and takes the responsibility for keeping them clean, and prosecuting those who despoil hem. Most pollution is, in fact, released into the air, oceans, and rivers precisely because there are no individual owners of those resources who have strong personal incentives to hold polluters liable for the damage they do. While some people do take the time and trouble to prosecute such polluters, there are few economic incentives for most people to do so.

Because of the above reason, here is where the Government’s role is necessary. By intervening, government can force the producers and consumers of the product to pay these cleanup costs. In essence, this economic role of government is simply to make those who enjoy the benefits of selling and consuming a product pays all of the costs of producing and consuming it. Unfortunately, it is rarely easy for the government to determine just how much it should do in these cases.

For one thing, it is usually difficult and costly to determine the precise source of pollution or exactly how much the pollution is actually costing society. Because of these difficulties, the government must be sure that it doesn’t impose more costs to reduce pollution than the pollution is costing society in the first place. Once he government has established an acceptable, or at least tolerable, level of pollution, it can use laws, regulations, fines, jail sentences, even special taxes to reduce the pollution.

Or even more fundamentally, it can try to establish clearer ownership rights for the resources that are being polluted, which will result in market-based prices being charged for the use of those resources and force polluters to pay those costs. Amid these many options, the key point is to understand the government’s basic role to correct for the overproduction and overcompensation of goods and services that lead to external costs.

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