Question Part (b) – Describe the neoclassical view of the free market system. How     

                                  do externalities? Occur in a free market? Why might some         

                                  forms of transport or travel listed in Table 1 cause externalities?  

The neoclassical view claims that the market regulates itself by allocating the resources it has in the most efficient way by linking the most efficient producer with the consumer who is willing to pay the most for the commodities. In this way the market sets a price that will maximize profits. This price mechanism has been described as “the invisible hand” (Adam Smith1776). It influences the behavior of sellers and buyers alike, all the while trying to maximize gain on both sides. This price actually consists of a wealth of information such as supply, demand, cost to produce and wealth of the key consumers. Simplifying it into a number allows sellers and buyers to make decisions that affect the market.

The neoclassical view contains the idea that consumers have a maximim price they are willing to pay for a commodity; if that price is exceeded they will not buy. Sellers also have a minimum price that they are willing to sell for, any lower and they make no profit. Matching these two is what a market does,

In an open market there are many producers of the same product, some may be more efficient than others and able to offer a lower price and these will make the most profit.

However this view is not complete, it does not take into account the myriad of by products and external consequences of the markets actions. The private costs of an action are those that effect only the buyer and seller, there are also social costs that effect agents not involved in the deal. These are known as externalities, unforeseen or unfortunate consequences of the action (or in some cases foreseen but uncared about consequences) these externalities have been described as the invisible elbow applying pressure to the invisible hand. The buyers and sellers in a market will try to maximize profits with little or no thought for the wider implications of their actions i.e. pollutiion

Externalities can be good or bad, consider a garden, it is planted to bring pleasure to the owner but as a by-product produces pleasure for those who live around it. However the same garden could have unfortunate consequences if a neighbor suffers from hay fever. In the market place externalities occur but if they do not directly affect the agents in the deal they do not figure into the price.

Most environmental problems caused by industry are negative externalities where the producers and consumers do not bear the full consequences of the action. The dumping of waste miles away from the site, the emissions of gasses that causes acid rain in another country, the depletion of fish stocks or other ecobalance disruptions are all examples of consequences borne by the wider community. What price can we put on that?

The problem with markets accepting responsibility for these externalities is it has to be unilateral as even if a company takes all that into account competitors who are more efficient and therefore able to offer a lower price are still doing the damage. Most consumers do not have the income to be able to pay more for a more environmentally sound product so the demand to produce it is missing. Governments put limits on companies and in some place green taxes to help repair the damage but that is still not much. Schemes such as the tax break on unleaded petrol and the increase in petrol duty as a whole are designed to make us use unleaded petrol and use our cars less. In fact all this does is reduce the ready income of people who rely on their cars for work and other activities.

Perhaps one solution would be to try to calculate the total cost of the markets into the price, include all the consequences into the price and make it compulsory to take into account externalities. This however would cause a rise in the price of goods and as has been shown consumers have a limit of what they are willing to pay. Organizations such as Green peace play a part by highlighting the environmental costs and have had some success in making the general public more aware of environmental damage but still few can afford the likes of organic, free-range produce.

The study of changing transport patterns as seen in part (a) has a few indications of externalities in itself.

It shows the predominant use of the car, cars causing much pollution and using up the exhaustible resource of oil, the users of cars vary rarely suffer the full effects of this pollution and will not really be effected by the exhaustibility of the resource as that will only be felt in future generations. The build up of greenhouse gasses and the increase in global warming are effects felt by us all, however they seem distant to the driver sitting in his car. However the effect of this pollution can sometimes even be felt by the driver i.e. the London smog, and this may have been encouragement to use public transport the decline in the more eco friendly methods of transport such as bicycle and walking indicates a lessening of concern, or a lessening of ability to do this. The increase in public transport in London is encouraging as this indicates a lessening of the amount of cars in the city, the recent congestion charge may improve that even further. The table shows a slight drop in car use in the last period of study, could this be due to environmental issues or merely cost imposed by the rise in all forms of car transport taxes.

In conclusion the market economy is a complicated system (indeed whole areas of study devoted to economics) and the issues of externalities may not be fully understood by the general populace but it seems that more attention is being paid to externalities now, especially in the area of transport.