We'd better get tough on environmental destruction wherever we find it, whatever it takes, because there's only one Earth.
It's tempting to think that this is a useful social policy.
When businesses were free to dump their waste anywhere they chose, it was impractical to eliminate all pollution.
Whenever we extract resources, manufacture goods, fertilize croplands, or power our electrical grid, there will be some amount of environmental damage.
To ensure that participants in markets are fully accounting for both social costs and benefits, the answer is to examine the tension between social costs and benefits.
In the previous chapters, we saw that markets provide many ben efits and that participants pursue their own self- interests.
Sometimes markets need help.
Some market exchanges harm innocent bystanders and some trades are not efficient because the ownership of property is not clearly defined.
Externalities and the differences between private and public goods are explored in this chapter.
Buyers and sellers benefit from trade.
Externalities are failures in the market.
In 2010, an offshore oil rig in the Gulf of Mexico operated by Brit allocation of resources in ish Petroleum exploded, causing millions of barrels of oil to spill into the market.
Many people along the Gulf Coast had their lives disrupted because of the production of oil.
Tourism and fishing, industries dependent on high environmental quality, were hit particularly hard by the costs of the spill.
The people who are not part of the congestion and pollution caused by our cars are external costs.
Some of the mechanisms that encourage external costs of a market consumers and producers to account for the social costs of their actions are considered in this section.
An externality exists when a private cost and a social cost differ.
The externality is negative if a third party is adversely affected.
When the number of vehicles on the roads causes activity to experience negative or positive externalities, it's called a negative externality.
It is difficult to make consumers and producers take responsibility for the full costs of their actions because of negative externalities.
Drivers usually only consider the internal costs of reaching their destination.
Similarly, manufacturers prefer to ignore the pollution they create because addressing the problem would raise their costs without providing them with significant benefits.
Society would benefit if all consumers and producers paid attention to both the internal and external costs of their actions.
Governments design policies to create incentives for firms and people to limit the amount of pollution they emit.
An effort by the city government of Washington, D.C. shows the power of this approach.
The city instituted a 5-cent tax on every plastic bag a consumer picks up.
5 cents doesn't sound like much, but shoppers have responded by using cloth bags or reuse plastic ones.
In Washington, D.C., the number of plastic bags used every month fell from 22 million in 2009 to 9 million in 2014).
Some externalities are positive.
There are positive externalities.
Education creates a large positive externality for society beyond the benefits to individual students, teachers, and support staff.
Employers look for qualified employees and are more efficient and productive if they have a more knowledgeable workforce.
Local businesses have a stake in the educational process because they experience a positive externality from a well educated local community.
California's Silicon Valley is home to many high- tech companies and is an example of the synergy between local business and higher education.
In the late 19th century, the leaders of the university felt that the mission should include fostering the development of self- sufficient local industry.
The creation of Hewlett- Packard, Bell Labs, and Xerox was the result of faculty and graduates starting their own companies after World War II.
This group of high tech firms gave birth to leading software and Internet firms like 3Com, Adobe, and Facebook.
Many of the most successful businesses in the area have donated large sums to the university because of the benefits they received.
The Hewlett Foundation gave $400 million to the humanities and sciences endowment at Stanford University in order to highlight the positive externality of the school.
The university has received large donations.
We look at ways to correct negative externalities.
Supply and demand analysis is used to understand how externalities affect the market.
In the case of an oil refinery, supply and the difference between what market forces produce and what is best for society should be compared.
A refinery makes gasoline.
The release of pollutants into the air and the dumping of waste by- products are some of the negative externalities generated by this complex process.
When oil refineries are allowed to pollute the environment without limits, they are likely to overproduce.
The deadweight loss that occurs from overproduction is eliminated.
When a negative externality occurs, the government may be able to restore the social optimum by forcing market participants to pay for their actions.
There are three possible solutions.
The refinery can be required to change production techniques to reduce emissions.
The government can impose a tax on the refinery to discourage it from producing.
The firm can be required to pay for any environmental damage it causes.
The amount of pollution causing activity is reduced by having to pay the costs of imposing pollution on others.
As a result of its actions, this result is visible.
The internal and external costs of producing the good are reflected in the new supply curve.
Because each corrective measure requires the refinery to spend money to correct the externality and therefore increases overall costs, the willingness to sell the good declines or shift to the left.
The result is a social optimum at a lower quantity.
The trade off is clear.
Producers are required to internalize the externality in order to reduce negative externalities.
Costs do not come without doing so.
The price goes up because the quantity produced is lower.
There is always a cost in the real world.
We considered deadweight loss in the context of government regulation.
Deadweight loss or an undesirable amount of economic activity can be created by these measures.
In the case of a negative externality, the market isn't efficient because it isn't capturing the cost of production.
Once the government intervenes and requires the firm to internalize the external costs of its production, output falls to the socially optimal level, and the deadweight loss from overproduction is eliminated.
The decision making process is outlined in Table 7.1.
Society as a whole experiences both internal and external costs, but private decision makers only consider their internal costs.
We need to find ways to encourage internalization of externalities to align the incentives of private decision makers with the interests of society.
Metro Washington, D.C., is notorious for traffic, but new express lanes keep traffic moving by using dynamic pricing, which adjusts tolls based on real- time traffic conditions.
Dynamic pricing helps manage the quantity demanded.
During less busy times, the express lane tolls can be as low as $0.20 per mile.
The higher rush- hour rates are designed to keep the express lanes free of congestion.
Motorists have to weigh the costs and benefits of driving into congested areas because of dynamic prices.
Motorists make marginal adjustments in terms of time when they drive because of the dynamic pricing of express lanes.
High demand times, such as the morning and evening rush, see higher tolls for using the express lanes and longer waits in the regular lanes.
Many motorists attempt to use the Beltway at off- peak times because they are faced with either sitting in traffic (if they don't pay the toll) or being charged more to enter the express lanes at peak- demand times.
The traffic flow spreads out as drivers internalize the costs.
Positive externalities, such as vaccines, are the result of economic activities that benefit third parties.
Economists use supply and demand analysis to compare the efficiency of the market with the social optimum.
The demand curve is the focus this time.
A person gets a flu shot.
The internal benefit is created when the vaccine is administered.
There is an external benefit.
Because the recipient won't get the flu, fewer people will catch the flu, which helps to protect those who don't get flu shots.
Positive externality to the rest of society can be provided by vaccines.
There is an incentive for people in high-risk groups to get a flu shot for the sake of their own health.
The market equilibrium only accounts for the internal benefits of individuals deciding whether to get vaccine.
School vaccination laws would require all children entering school to provide proof of vaccine against a variety of diseases.
Positive benefits for all members of society can be created by internalizing the externality of the requirement.
The market will be pushed toward the socially optimal number of vaccinations if more people get vaccine early in life.
In the United States, vaccination rates have been falling for years.
There are both individual and social benefits to the lower vaccination rate.
Measles can spread quickly when the vaccine rate is not 100%, as evidenced by the outbreak that spread to six U.S. states, Mexico, and Canada.
Eco nomic activity that helps third parties can be promoted by the government.
It can offer a price break to encourage people to get vaccinations.
Market inefficiencies increase the demand for vaccines, which raises the overall market price.
Governments give free or reduced cost vaccines to those most at risk from flu.
The social demand curve shows the benefits of getting the vaccine.
Consumers are encouraged to internalize the externality of the subsidy.
Markets don't handle externalities well.
Too much of a good can be produced by the market with a negative externality.
In the case of a positive externality, the market produces too little.
Deadweight loss is created by the market equilibrium.
The private market is not efficient when positive externalities are present.
The market equilibrium doesn't maximize the gains for society as a whole.
The demand curve shifts outward when positive externalities are present.
The deadweight loss that results from insufficient market demand is eliminated.
The key characteristics of positive and negative externalities are summarized in Table 7.2.
Not all externalities warrant cor rective measures.
Sometimes the size of the externality is not justified by the cost of increased regulations, charges, taxes, or subsidies that might achieve the social optimum.
The presence of negligible externalities does not mean that the government should intervene in the market.
The spread of disease is prevented by flu shots.
Motorists spend more time on the road and citizens spend less time on the road.
Historic buildings help with pollution.
Pennsylvania, Texas, West Virginia, and Wyoming are some of the states where energy companies have begun using the process known as frack to extract natural gas.
Water, chemicals, and sand are injected into rock formations.
Natural gas is trapped in the rocks and can be released through the process.
Much of the water and chemical mixture must be thrown away because it came to the surface.
Controversy has grown about the potential environmental effects of the process as it has expanded.
People who live near wells worry about the pollutants in the water mixture and their potential to ruin drinking water supplies.
The drilling of a well is noisy.
For a few weeks, drilling occurs 24 hours a day.
Anyone who lives close by is affected by this noise pollution.
The natural gas has to be moved away from the well.
Local roads can be damaged by additional truck traffic.
The areas where it is occurring have seen tremendous economic growth.
Many people have been employed because of the jobs that have been created.
As temporary employees move from one area to another, local hotels and restaurants have seen an increase in business.
As permanent employees take over the operation of a well, housing prices go up, which benefits local homeowners.
The government doesn't need to force everyone to shower.
People with bad body odor have every reason to shower, use extra strength deodorant, or use cologne to mask the smell on their own.
They will be ostracized if they don't avail themselves of these options.
It is best to leave alone because government regulations to completely eliminate the externality would be quite burdensome.
There is a divide between the way markets operate and the social optimum.
Resources can over resources if property rights are not clearly defined.
Manufacturing firms emit pollutants into the air because no one owns it.
We need to examine the role of property rights in market efficiency to understand why firms sometimes overlook their actions.
When we compare situations in which people have property rights, the difference is obvious.
Private owners have an incentive to keep their property in good repair because they bear the costs of fixing what they own when it breaks or no longer works properly.
If you own a personal computer, you should treat it with care and deal with any problems as soon as possible.
If you find that a public computer terminal in a campus lab is malfunctioning, you will most likely ignore the problem and look for another computer that is working.
Property rights matter because of the difference between solving the problem and ignoring it.
This right creates an incen that allows for the use, and tives to maintain, protect, and conserve property and to trade with others.
There is an incentive for car owners to maintain their vehicles.
The vehicle is safe and reliable because of regular maintenance and repairs.
There is an incentive for owners to protect their vehicles.
They use alarm systems, locking doors, and parking in well lit areas to protect their property.
Car owners can extend the usable life of their cars by limiting the number of miles they drive each year.
Car owners have an incentive to trade with each other.
You can do what you want with the car.
If you decline to sell, you will have to give up $5,000 to keep the item you value at $3,000.
The owner of private property has an incentive to trade for something better in the market.
Incentives to maintain, protect, and conserve property help to ensure that owners keep their private property in good shape.
The fourth incentive, to trade with others, helps to ensure that private property is held by the person with the greatest willingness to pay.
Ronald Coase argued in 1960 that private property rights can close the gap between internal and social costs.
Consider an example of two people who are next to each other, one raising cattle and the other wheat.
The cattle wander onto the neighboring land to eat wheat because neither of the owners built a fence.
Both parties are to blame for the dilemma.
He looked at two possible scenarios to arrive at the conclusion.
The wheat farmer has the right to expect cattle- free fields.
The cattle rancher is responsible for the damage done to the wheat farmer.
If the damage is costly and the rancher is responsible, the rancher will build a fence to keep the cattle out.
The fence makes the rancher pay the full cost of the damage.
The rancher is more likely to compensate the wheat farmer if the damage to the crop is less than the cost of building a fence.
The cattle rancher is not responsible for the damages his cattle cause to the wheat farmer.
The cattle are close to the wheat.
The wheat farmer is forced to pay the full cost of the damage because of the fence.
The farmer may accept occasional damage as a lower cost option if it is less than the cost of a fence.
When the externality is large enough to justify the expense, the externality gets internalize.
Either the cattle rancher or the wheat farmer will build a fence if the property rights are fully specified.
The fence will keep the cattle away from the wheat and prevent the destruction of the property.
The incentive to internalize any externalities is given by the assignment of property rights under the law interested parties will bar.
It is difficult to correct externalities.
Private solutions to externality problems are not always possible, implying a role for government in solving complex externality issues.
Consider the difference between an example of a rancher and a farmer with adjacent land and an example of a community- wide problem such as pollution.
The parties can bargain with each other at a low cost, which should make a private solution possible.
The externality is absorbed by a fence.
Because of the high bargaining costs in the case of pollution, the government may be necessary.
Most of us imagine a slice of pizza or a jacket when we think of private goods.
When it is possible to prevent consumers from having production, the terms "private" and "public" are used, but they are not the criterion that economists use to categorize private not paid for it from having and public goods.
To understand the difference between public and private access.
Only one person can eat a slice of pizza.
Consider opening a pizza business.
The pizzeria knows it can sell pizzas to consumers.
Consumers are willing to buy pizza because they enjoy it.
Many of the nation's best fireworks displays, but only a small percentage of difficult to exclude, can be seen by hundreds of thousands of people.
Consumers can't be forced to pay to watch fireworks, so they may want more of the good.
fireworks displays and other public goods are underproduced because of the market economy.
People can get public goods without paying for them.
Public goods result in market failure.
Joshua Bell is one of the most famous violinists in the world.
After giving a concert in Boston for $100 a ticket, he decided to perform in a Pizza is a private good.
Asking for donations at the subway station in Washington, D.C.
The music did not need to be purchased to be enjoyed.
It was nonrival in consumption.
It is difficult for a street musician to make a living because they can't force people to pay.
If he draws a large crowd and the music is good, the audience will enjoy $500 worth of music.
He received a loud round of applause at the end of the performance and then moved to the donation basket.
When he counts up the contributions, he only finds $30, the actual amount he earned while playing in the Metro.
Whenever someone gets lic good, a street musician gives a pub to them and they need the audience's help to pay for it.
Many potential musicians won't pay for it if it's a benefit without a lot of people contributing.
The event is placed in a hypothetical context.
Market inefficiencies lower the returns to performing and the private equilibrium amount of street performances is undersupplied in comparison to the social optimum.
The efficient quantity is not produced when payment cannot be linked to production or consumption.
There are many examples of a public good.
National defense is an example of a public good that is subject to a free- rider problem.
Only the government can provide adequate national defense.
Society would not be protected because many people wouldn't pay their fair share.
Defense expenditures are usually funded by tax revenues.
The free- rider problem is almost eliminated because most people pay taxes.
National defense, the interstate highway system, and medical and science related research should be provided by the government.
Public sector provision helps to eliminate the free- rider problem and create a socially optimal level of activity.
Group work is required in a class.
The ability to work as a team is a skill that businesses look for in potential employees.
The free- rider problem can be created by group work in class or the workplace.
Many groups have one member who doesn't put in the time or effort to complete the project.
The person knows that he or she will get the benefit of the group grade without paying the full cost.
You might think that this behavior is lazy or inconsiderate, but it is actually quite rational.
The free rider is wondering if his or her actions will affect the group's grade.
If the work raises the group's grade from a B- to a B, the free rider may find it too costly to participate.
Common- resource goods have characteristics that are excludable.