Government Mechanism of Adjusting for Externalities:

Since external benefits and costs affect the market in their own ways, it becomes necessary for government to take various steps to control or adjust these externalities.

Few mechanisms are discussed below:

1) Enforcement of Property Rights

Government prevents inefficiency by clearly defining and enforcing property rights as the numbers of persons involved are very large

Example:

a) Cable television services scramble their transmissions so that non-subscribers cannot receive broadcasts.

b) Private roads finance themselves by charging tolls to road users.

c) People staying in polluted areas are affected because people wait for someone else to act, knowing that they will benefit from pollution control. The judicial process can deal this external cost.

2) Tax on output

Since production and consumption of commodities generate pollution that harms the society, and such activities can be taxed.

Example: Tax on automobiles would mean to reduce their numbers and by there would reduce air pollution from that source.

3) Tax on emissions and effluents

With an emissions tax, some control is likely be obtained by changing the production process so that less pollution is generated per unit of output.

Example: Emission  tax on autos would encourage production of low-emission cars.  Such cars might be more expensive may induce and decline in their output.

4) Standard and Regulation

Government can enforce certain standards and attempt thereby to directly control the level of pollution. Standard involves complying with quality the cost of which is to be borne by producers or customers according to the good they produce or buy. Thus  enforcement of such standards and regulations helps the government to correct externalities problems.

5) Pollution Permits

Government can create and sell permits to pollute, and thus, prohibiting pollution unless a permit is purchased.

Example: A pollution permit might entitle its owner, say an iron producer, to allow one ton of a particular gas or dust to escape into the atmosphere each month. The number of permits issued would be determined by air (or water) quality that is sought.

6) Subsidies for Pollution Control

Subsidy may take the form of the direct grants or tax breaks for producers that install specified pollution control equipment. It may be used in conjunction with standards.

Example: Federal government imposes standards on sewage treatment by cities and provides federal grants for construction of sewage treatment facilities.