Question: Petroleum firms drill for oil in the Gulf Coast. Accidents on oil rigs that cause spills impose a negative externality on the inhabitants of the Gulf Coast states. Identify two ways oil drilling and its harmful effects could be reduced using your knowledge of externalities and behavioral economics.

The process of oil drilling causes spills that harm the wildlife and other inhabitants of the gulf coast. It is a negative externality. While creating negative externalities, the firms transfer the burden of cost to society. Since nature does not cost any monetary value, firms exploit it and reduce their marginal private cost. Thus, the marginal social cost exceeds the marginal cost, and firms enjoy greater profits from larger production.

The government can impose tax either on the production or the pollutants emitted during the production. An increase in taxes will raise the marginal private cost (MPC) of production till it matches the marginal social cost. A higher MPC will reduce the output to an optimal level, and thus pollutants emitted will be controlled.

Another measure to limit oil spills can be to reduce demand for oil by consumers. Out of self-awareness, education, and eco-friendly concerns, if consumers switch to other energy-efficient fuels, the oil demand will fall. It will lead to lesser oil drilling and spills on the gulf coast, which will normalize the environment for inhabitants.

For example, oil is most demanded for vehicles derived from diesel and petrol. If consumers switch to CNG vehicles or electric vehicles, the oil demand will fall significantly. It will reduce oil production, and spills will not disturb inhabitants' lives in the oil-producing areas.