Market failures

Three kinds of market failure
(1) market power--- supplier can set the price
(2) lack of information
(3) externality

The idea of externality charge is not to discourage everyone from doing anything that might inconvenience anybody else; it is to get them take into consideration the effect they cause to others.

Congestion charging not only improves efficiency, it redistribute the money from the rich. Externality charge makes other alternatives more attractive.

Individually, constantly make decisions that put a value on environment, on time and even on our own life. If you pay more for a department that is in a peaceful and quiet neighbourhood, you have already put the value on quiet and peace.

Revealed preference: people's preference is revealed when they make choices as consumers.

The use of externality charges do rely in the shaky knowledge about how much it is really worth to us to reduce externalities like pollution, noise, etc. We also do not know the cheapest way to reduce the externalities.

Nobody knows the cheapest way of solving our traffic problems--yet. But externality pricing brings pollution, congestion, and the rest inside the world of truth, which market creates for us.

The attractive thing about externality pricing is that it attacks the problem but makes no assumption about the solution. The congestion charge gives drivers a signal: by bringing your car into town in rush hour, you are imposing a cost on everyone else. The drivers then have a choice: pay compensation, or find a way to avoid imposing the cost. There are many, many ways to avoid that cost, and the market can produce the ingenuity needed to uncover them. When no externalities are present, markets automatically take account of costs and provide incentives for producers to reduce them. When externalities are present, those costs are invisible to the market, but systems such as externality charging provide the missing signal that the cost exists.

Although externality charge and subsidy seem a great fix for externalities, there may be an unexpected hiccup.

Externalities simply are not externalitoes if people can easily get together and negotiate. Remember that they were called "externalities" because they stood outside market transactions.

With the existence of pseudoexternalities, which can in fact be dealt with very well by the private sector, if the government also steps in with an externality charge, we may find ourselves "solving" the externality twice.