How to avoid environmental damage in the economy

How do we avoid environmental damage in an expanding economy?

It is not easy because a lot of environmental damage occurs as a result of negative externalities. In other words, the environmental damage from producing a good, driving a car primarily affects other people. Therefore, free markets are not efficient at dealing with environmental externalities. As economists, we also need to consider the impact on the wider economy.

To prevent environmental damage we need to:

1. Internalise Externalities

We need people to pay the social cost of driving, producing goods. Suppose the cost of driving a car is £1 per 10 miles. The social cost may be £3.50 because of the additional pollution externalities. Therefore, the government needs to place a tax of £2.50 on driving so that people pay the true social cost and reduce consumption of goods which cause pollution. The revenue can be used to offset the negative effects of pollution.

tax-negative-externality-pigovian-tax A tax reduces demand from Q1 to Q2.

2. Global Initiatives


Another problem with pollution is that it needs global coordination. If the UK reduce pollution emissions by 50% it would make little impact on reducing global warming if China and the US continued to increase their pollution levels.

3. Consider future generations

Pollution doesn’t just affect present generations it will affect future generations even more. This cost needs to be built in today’s prices. A problem is when making decisions the free market does not include the cost of today’s actions on the future generations.

4. Regulations

Sometimes tax may be insufficient to deal with pollution problems therefore it may be more effective to simply ban certain practices such as burning coal or SUVs with 4-litre engines.

5. Technology for cleaner energy

The biggest difference may come through better technology which provides pollution-free energy sources. This will require investment and may be accelerated subsidy by the government. But, would probably be more popular than higher taxes.


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