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11 Dec 2025
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Understanding Negative Externalities in Economics
Tanvir Ahmed
@txnvir_ahmed
1 / 5
Negative Externalities and Government Intervention
Ever wondered why petrol prices keep rising or why some factories face strict emission limits? It's all about negative externalities - the hidden costs that businesses pass on to society.
When firms only consider their private costs and ignore external damage like pollution, they end up overproducing. This creates a deadweight loss where society suffers from too much harmful production.
The government has two main weapons to tackle this: indirect taxation and regulation. Both aim to force businesses to account for the true social cost of their actions.
Key Point: Without intervention, firms will always produce more than what's socially optimal because they don't pay for the damage they cause.
Taxation as a Solution
Think of environmental taxes as making polluters pay for the mess they create. By slapping an indirect tax on harmful goods, the government makes production more expensive, which naturally reduces supply.
The tax shifts the firm's cost curve upward, moving the market from overproduction to the socially optimal level. This follows the polluter pays principle - if you cause the damage, you foot the bill.
The numbers speak for themselves: UK environmental taxes raised around £50 billion in revenue, and CO2 levels dropped by roughly 10% between 2019 and 2020. That's real impact you can measure.
Success Story: Environmental taxation has proven effective, generating billions in revenue whilst cutting emissions by 10% in just one year.
When Taxation Backfires
Here's where things get tricky - taxation can seriously backfire when dealing with price inelastic demand. Energy is a perfect example because people can't simply stop using electricity or heating.
When demand is inelastic, you need massive tax increases to reduce consumption significantly. The problem? Most of this tax burden gets passed straight onto consumers through higher prices.
This hits low-income households hardest because they can't afford to reduce their consumption of essential goods like energy. What started as an environmental policy ends up increasing inequality across the country.
The diagrams show this clearly: when demand is inelastic, the consumer burden far exceeds the producer burden, making everyday essentials unaffordable for those who need them most.
Reality Check: Taxing essential goods with inelastic demand often punishes poor households more than the polluting companies.
Regulation: Setting Hard Limits
Sometimes the government ditches the carrot and goes straight for the stick through direct regulation. Instead of hoping taxes will reduce production, they simply set legal limits on output or emissions.
The US Supreme Court gave the EPA power to regulate greenhouse gas emissions from power plants and factories in 2014. Firms that exceed these limits face serious sanctions - no negotiations, no exceptions.
This approach eliminates the deadweight loss immediately by capping production at the socially optimal level. Quantity drops from the market level to the social optimum, automatically pushing prices up to reflect true social costs.
Results have been impressive: the US has seen sustained falls in greenhouse gas emissions since 2008, with regulations accelerating this decline after 2014.
Direct Impact: Unlike taxes, regulations create immediate, measurable cuts in harmful production with no room for companies to buy their way out.
The Hidden Costs of Regulation
Don't celebrate too quickly though - regulation comes with serious drawbacks that often get overlooked. Setting up administrative departments to monitor and enforce compliance across thousands of firms costs a fortune.
The UK's approach shows this challenge: instead of formal CO2 limits, large firms only need to report their emission levels. Why? Because proper enforcement would create massive opportunity costs for government spending.
Even worse, regulations can accidentally create monopolies. Large profitable firms can afford to pay fines and exceed limits, whilst smaller competitors get forced out of the market. This reduces competition and pushes up prices for consumers.
Once again, low-income households bear the brunt through higher prices on essential goods. The cure starts looking worse than the disease when consumer welfare takes such a hit.
Trade-off Alert: Effective regulation requires huge government resources and risks creating monopolies that harm consumers more than the original pollution problem.
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Best app on earth! no words because it’s too good
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This app has made me feel so much more confident in my exam prep, not only through boosting my own self confidence through the features that allow you to connect with others and feel less alone, but also through the way the app itself is centred around making you feel better. It is easy to navigate, fun to use, and helpful to anyone struggling in absolutely any way.
David K
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The app's just great! All I have to do is enter the topic in the search bar and I get the response real fast. I don't have to watch 10 YouTube videos to understand something, so I'm saving my time. Highly recommended!
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In school I was really bad at maths but thanks to the app, I am doing better now. I am so grateful that you made the app.
Greenlight Bonnie
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very reliable app to help and grow your ideas of Maths, English and other related topics in your works. please use this app if your struggling in areas, this app is key for that. wish I'd of done a review before. and it's also free so don't worry about that.
Rohan U
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I know a lot of apps use fake accounts to boost their reviews but this app deserves it all. Originally I was getting 4 in my English exams and this time I got a grade 7. I didn’t even know about this app three days until the exam and it has helped A LOT. Please actually trust me and use it as I’m sure you too will see developments.
Xander S
iOS user
THE QUIZES AND FLASHCARDS ARE SO USEFUL AND I LOVE THE SCHOOLGPT. IT ALSO IS LITREALLY LIKE CHATGPT BUT SMARTER!! HELPED ME WITH MY MASCARA PROBLEMS TOO!! AS WELL AS MY REAL SUBJECTS ! DUHHH 😍😁😲🤑💗✨🎀😮
Elisha
iOS user
This apps acc the goat. I find revision so boring but this app makes it so easy to organize it all and then you can ask the freeeee ai to test yourself so good and you can easily upload your own stuff. highly recommend as someone taking mocks now
Paul T
iOS user
The app is very easy to use and well designed. I have found everything I was looking for so far and have been able to learn a lot from the presentations! I will definitely use the app for a class assignment! And of course it also helps a lot as an inspiration.
Stefan S
iOS user
This app is really great. There are so many study notes and help [...]. My problem subject is French, for example, and the app has so many options for help. Thanks to this app, I have improved my French. I would recommend it to anyone.
Samantha Klich
Android user
Wow, I am really amazed. I just tried the app because I've seen it advertised many times and was absolutely stunned. This app is THE HELP you want for school and above all, it offers so many things, such as workouts and fact sheets, which have been VERY helpful to me personally.
Anna
iOS user
Best app on earth! no words because it’s too good
Thomas R
iOS user
Just amazing. Let's me revise 10x better, this app is a quick 10/10. I highly recommend it to anyone. I can watch and search for notes. I can save them in the subject folder. I can revise it any time when I come back. If you haven't tried this app, you're really missing out.
Basil
Android user
This app has made me feel so much more confident in my exam prep, not only through boosting my own self confidence through the features that allow you to connect with others and feel less alone, but also through the way the app itself is centred around making you feel better. It is easy to navigate, fun to use, and helpful to anyone struggling in absolutely any way.
David K
iOS user
The app's just great! All I have to do is enter the topic in the search bar and I get the response real fast. I don't have to watch 10 YouTube videos to understand something, so I'm saving my time. Highly recommended!
Sudenaz Ocak
Android user
In school I was really bad at maths but thanks to the app, I am doing better now. I am so grateful that you made the app.
Greenlight Bonnie
Android user
very reliable app to help and grow your ideas of Maths, English and other related topics in your works. please use this app if your struggling in areas, this app is key for that. wish I'd of done a review before. and it's also free so don't worry about that.
Rohan U
Android user
I know a lot of apps use fake accounts to boost their reviews but this app deserves it all. Originally I was getting 4 in my English exams and this time I got a grade 7. I didn’t even know about this app three days until the exam and it has helped A LOT. Please actually trust me and use it as I’m sure you too will see developments.
Xander S
iOS user
THE QUIZES AND FLASHCARDS ARE SO USEFUL AND I LOVE THE SCHOOLGPT. IT ALSO IS LITREALLY LIKE CHATGPT BUT SMARTER!! HELPED ME WITH MY MASCARA PROBLEMS TOO!! AS WELL AS MY REAL SUBJECTS ! DUHHH 😍😁😲🤑💗✨🎀😮
Elisha
iOS user
This apps acc the goat. I find revision so boring but this app makes it so easy to organize it all and then you can ask the freeeee ai to test yourself so good and you can easily upload your own stuff. highly recommend as someone taking mocks now
Paul T
iOS user
Understanding Negative Externalities in Economics
Tanvir Ahmed
@txnvir_ahmed
When businesses cause pollution or other harmful side effects, the government often steps in to fix the problem. There are two main tools they use: taxes and regulations, each with their own advantages and serious drawbacks.
Negative Externalities and Government Intervention
Ever wondered why petrol prices keep rising or why some factories face strict emission limits? It's all about negative externalities - the hidden costs that businesses pass on to society.
When firms only consider their private costs and ignore external damage like pollution, they end up overproducing. This creates a deadweight loss where society suffers from too much harmful production.
The government has two main weapons to tackle this: indirect taxation and regulation. Both aim to force businesses to account for the true social cost of their actions.
Key Point: Without intervention, firms will always produce more than what's socially optimal because they don't pay for the damage they cause.
Sign up to see the contentIt's free!
Access to all documents
Improve your grades
Join milions of students
By signing up you accept Terms of Service and Privacy Policy
Taxation as a Solution
Think of environmental taxes as making polluters pay for the mess they create. By slapping an indirect tax on harmful goods, the government makes production more expensive, which naturally reduces supply.
The tax shifts the firm's cost curve upward, moving the market from overproduction to the socially optimal level. This follows the polluter pays principle - if you cause the damage, you foot the bill.
The numbers speak for themselves: UK environmental taxes raised around £50 billion in revenue, and CO2 levels dropped by roughly 10% between 2019 and 2020. That's real impact you can measure.
Success Story: Environmental taxation has proven effective, generating billions in revenue whilst cutting emissions by 10% in just one year.
Sign up to see the contentIt's free!
Access to all documents
Improve your grades
Join milions of students
By signing up you accept Terms of Service and Privacy Policy
When Taxation Backfires
Here's where things get tricky - taxation can seriously backfire when dealing with price inelastic demand. Energy is a perfect example because people can't simply stop using electricity or heating.
When demand is inelastic, you need massive tax increases to reduce consumption significantly. The problem? Most of this tax burden gets passed straight onto consumers through higher prices.
This hits low-income households hardest because they can't afford to reduce their consumption of essential goods like energy. What started as an environmental policy ends up increasing inequality across the country.
The diagrams show this clearly: when demand is inelastic, the consumer burden far exceeds the producer burden, making everyday essentials unaffordable for those who need them most.
Reality Check: Taxing essential goods with inelastic demand often punishes poor households more than the polluting companies.
Sign up to see the contentIt's free!
Access to all documents
Improve your grades
Join milions of students
By signing up you accept Terms of Service and Privacy Policy
Regulation: Setting Hard Limits
Sometimes the government ditches the carrot and goes straight for the stick through direct regulation. Instead of hoping taxes will reduce production, they simply set legal limits on output or emissions.
The US Supreme Court gave the EPA power to regulate greenhouse gas emissions from power plants and factories in 2014. Firms that exceed these limits face serious sanctions - no negotiations, no exceptions.
This approach eliminates the deadweight loss immediately by capping production at the socially optimal level. Quantity drops from the market level to the social optimum, automatically pushing prices up to reflect true social costs.
Results have been impressive: the US has seen sustained falls in greenhouse gas emissions since 2008, with regulations accelerating this decline after 2014.
Direct Impact: Unlike taxes, regulations create immediate, measurable cuts in harmful production with no room for companies to buy their way out.
Sign up to see the contentIt's free!
Access to all documents
Improve your grades
Join milions of students
By signing up you accept Terms of Service and Privacy Policy
The Hidden Costs of Regulation
Don't celebrate too quickly though - regulation comes with serious drawbacks that often get overlooked. Setting up administrative departments to monitor and enforce compliance across thousands of firms costs a fortune.
The UK's approach shows this challenge: instead of formal CO2 limits, large firms only need to report their emission levels. Why? Because proper enforcement would create massive opportunity costs for government spending.
Even worse, regulations can accidentally create monopolies. Large profitable firms can afford to pay fines and exceed limits, whilst smaller competitors get forced out of the market. This reduces competition and pushes up prices for consumers.
Once again, low-income households bear the brunt through higher prices on essential goods. The cure starts looking worse than the disease when consumer welfare takes such a hit.
Trade-off Alert: Effective regulation requires huge government resources and risks creating monopolies that harm consumers more than the original pollution problem.
We thought you’d never ask...
What is the Knowunity AI companion?
Our AI Companion is a student-focused AI tool that offers more than just answers. Built on millions of Knowunity resources, it provides relevant information, personalised study plans, quizzes, and content directly in the chat, adapting to your individual learning journey.
Where can I download the Knowunity app?
You can download the app from Google Play Store and Apple App Store.
Is Knowunity really free of charge?
That's right! Enjoy free access to study content, connect with fellow students, and get instant help – all at your fingertips.
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Most popular content: Negative Externality
Most popular content in Economics
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Can't find what you're looking for? Explore other subjects.
Students love us — and so will you.
4.9/5
App Store
4.8/5
Google Play
The app is very easy to use and well designed. I have found everything I was looking for so far and have been able to learn a lot from the presentations! I will definitely use the app for a class assignment! And of course it also helps a lot as an inspiration.
Stefan S
iOS user
This app is really great. There are so many study notes and help [...]. My problem subject is French, for example, and the app has so many options for help. Thanks to this app, I have improved my French. I would recommend it to anyone.
Samantha Klich
Android user
Wow, I am really amazed. I just tried the app because I've seen it advertised many times and was absolutely stunned. This app is THE HELP you want for school and above all, it offers so many things, such as workouts and fact sheets, which have been VERY helpful to me personally.
Anna
iOS user
Best app on earth! no words because it’s too good
Thomas R
iOS user
Just amazing. Let's me revise 10x better, this app is a quick 10/10. I highly recommend it to anyone. I can watch and search for notes. I can save them in the subject folder. I can revise it any time when I come back. If you haven't tried this app, you're really missing out.
Basil
Android user
This app has made me feel so much more confident in my exam prep, not only through boosting my own self confidence through the features that allow you to connect with others and feel less alone, but also through the way the app itself is centred around making you feel better. It is easy to navigate, fun to use, and helpful to anyone struggling in absolutely any way.
David K
iOS user
The app's just great! All I have to do is enter the topic in the search bar and I get the response real fast. I don't have to watch 10 YouTube videos to understand something, so I'm saving my time. Highly recommended!
Sudenaz Ocak
Android user
In school I was really bad at maths but thanks to the app, I am doing better now. I am so grateful that you made the app.
Greenlight Bonnie
Android user
very reliable app to help and grow your ideas of Maths, English and other related topics in your works. please use this app if your struggling in areas, this app is key for that. wish I'd of done a review before. and it's also free so don't worry about that.
Rohan U
Android user
I know a lot of apps use fake accounts to boost their reviews but this app deserves it all. Originally I was getting 4 in my English exams and this time I got a grade 7. I didn’t even know about this app three days until the exam and it has helped A LOT. Please actually trust me and use it as I’m sure you too will see developments.
Xander S
iOS user
THE QUIZES AND FLASHCARDS ARE SO USEFUL AND I LOVE THE SCHOOLGPT. IT ALSO IS LITREALLY LIKE CHATGPT BUT SMARTER!! HELPED ME WITH MY MASCARA PROBLEMS TOO!! AS WELL AS MY REAL SUBJECTS ! DUHHH 😍😁😲🤑💗✨🎀😮
Elisha
iOS user
This apps acc the goat. I find revision so boring but this app makes it so easy to organize it all and then you can ask the freeeee ai to test yourself so good and you can easily upload your own stuff. highly recommend as someone taking mocks now
Paul T
iOS user
The app is very easy to use and well designed. I have found everything I was looking for so far and have been able to learn a lot from the presentations! I will definitely use the app for a class assignment! And of course it also helps a lot as an inspiration.
Stefan S
iOS user
This app is really great. There are so many study notes and help [...]. My problem subject is French, for example, and the app has so many options for help. Thanks to this app, I have improved my French. I would recommend it to anyone.
Samantha Klich
Android user
Wow, I am really amazed. I just tried the app because I've seen it advertised many times and was absolutely stunned. This app is THE HELP you want for school and above all, it offers so many things, such as workouts and fact sheets, which have been VERY helpful to me personally.
Anna
iOS user
Best app on earth! no words because it’s too good
Thomas R
iOS user
Just amazing. Let's me revise 10x better, this app is a quick 10/10. I highly recommend it to anyone. I can watch and search for notes. I can save them in the subject folder. I can revise it any time when I come back. If you haven't tried this app, you're really missing out.
Basil
Android user
This app has made me feel so much more confident in my exam prep, not only through boosting my own self confidence through the features that allow you to connect with others and feel less alone, but also through the way the app itself is centred around making you feel better. It is easy to navigate, fun to use, and helpful to anyone struggling in absolutely any way.
David K
iOS user
The app's just great! All I have to do is enter the topic in the search bar and I get the response real fast. I don't have to watch 10 YouTube videos to understand something, so I'm saving my time. Highly recommended!
Sudenaz Ocak
Android user
In school I was really bad at maths but thanks to the app, I am doing better now. I am so grateful that you made the app.
Greenlight Bonnie
Android user
very reliable app to help and grow your ideas of Maths, English and other related topics in your works. please use this app if your struggling in areas, this app is key for that. wish I'd of done a review before. and it's also free so don't worry about that.
Rohan U
Android user
I know a lot of apps use fake accounts to boost their reviews but this app deserves it all. Originally I was getting 4 in my English exams and this time I got a grade 7. I didn’t even know about this app three days until the exam and it has helped A LOT. Please actually trust me and use it as I’m sure you too will see developments.
Xander S
iOS user
THE QUIZES AND FLASHCARDS ARE SO USEFUL AND I LOVE THE SCHOOLGPT. IT ALSO IS LITREALLY LIKE CHATGPT BUT SMARTER!! HELPED ME WITH MY MASCARA PROBLEMS TOO!! AS WELL AS MY REAL SUBJECTS ! DUHHH 😍😁😲🤑💗✨🎀😮
Elisha
iOS user
This apps acc the goat. I find revision so boring but this app makes it so easy to organize it all and then you can ask the freeeee ai to test yourself so good and you can easily upload your own stuff. highly recommend as someone taking mocks now
Paul T
iOS user