Externalities - The Full Cost of the Choices we make

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to think like an economist. We're recording this in the
middle of a pandemic, and we're hearing all about how
we should be wearing masks, but it seems like not
enough people are following this advice.
A mask doesn't just protect the person wearing it, it
also prevents other people from getting infected by you. However,
a lot of people are still resistant to wearing them.
You know, this is a more common problem than you'd think.
There are a lot of things that we should do
as citizens which are annoying or inconvenient, or we can't
really be bothered to do, even though it would be
good for the world if we did them.
The bigger point is that most of our choices have
effects on other people too, and they can be good
effects or bad effects. We call these side effects externalities,
and that's what we'll be looking at. On this week's
episode of Think Like an Economist, I'm just a Wolphus and.
I'm Betsy Stevenson, and we're teaching you the super tools
of economics to help you make the best decisions possible.
NAS trend tab Acholi forus with Us Today.
So this issue of mask wearing is huge whenever there's
a highly contagious airborne disease like COVID. It's also a
very effective way to understand externalities, which also come up
a lot when we talk about climate change and pollution
and matters to do with the environment more generally. In fact,
it seems like a lot of our biggest challenges on
a global scale right now involve externalities.
Yes, and externality show us the limitations of relying on
markets too much. There are two types of externalities, positive externalities,
or activities where other people benefit from you taking some action.
Mask wearing is a great example. If I wear a mask,
not only am I less likely to catch COVID nineteen,
but I'm also reducing the risk of passing the virus
onto other people if I indeed have it. Vaccines can
acsimile make you less likely to pass along a disease
to others.
We also have negative externalities, which are activities which impose
costs on other people. The biggest example is pollution, because
our use of carbon is contributing to climate change, and
that big cost is being ignored by most people when
they go to make individual daily decisions. You know, and
to personalize it a bit, whenever you drive your car
releases emissions which pollute the atmosphere and contribute to climate change.
So your choices contribute to climate change, and externalities seem
to be especially important when it comes to the environment.
The problem with externalities is that because other people either
benefit or suffer from our activities, we don't usually consider
the impact on them as much, or sometimes we may
underestimate this impact or not even be aware of it
in the first place. Therefore, we end up making decisions
which may work for us, but which aren't the best
for everyone else.
Remember the rational rule states that we should do something
or buy something if the marginal benefit is more than
the marginal cost. Well, what we really should consider is
if the marginal benefit to society as a whole is
bigger than the marginal cost to society as a whole.
Economists call this idea marginal social benefits and marginal social costs.
Adding the word social is a reminder to take the
full set of costs and benefits, including those that accrue
to others, into account as well.
Now, let's dig in to see how we can make
decisions where the marginal social benefit is more than the
marginal social cost. Let's start with positive externalities and let's
stick to mask wearing. So a lot of us are
wearing masks when we go out and about, but they're
pretty uncomfortable and they are a nuisance to remember to
carry around. But I guess some people find that keeping
safe isn't worth the hassle of wearing a mask.
Yes, And that's the problem in that they tend to
focus on the costs and benefits that they face or
their friends face, and ignore at least some of the
benefits to others. So, if you're going to see your
ninety four year old grandmother, you're more inclined to wear
a mask than if you're in a store that has well,
someone else's ninety four year old grandmother in it. Now
you'll remember from the rational rule that will buy something
or in this case, do something if the marginal benefit
is more then or at least the same as the
marginal cost.
So everyone else benefits, for example, from Justin wearing a mask,
and if he doesn't wear a mask, he increases the
risks of other people getting the virus if he were infected.
So society also faces costs and benefits that are based
on Justin's decision to wear a mask.
And the problem is that when Justin is deciding if
he should wear a mask, he's only thinking about the
costs and benefits for him, rather than for everyone else too.
Let's be fair. I'm not a total jerk. I care
about other people, but it's hard to care about everyone
with the same intensity that you care about yourself. The
more that people actually do care about other people, the
more likely they are to do what's best for society.
But it takes a saint to put the same weight
on eight billion other people on the planet as you
do on yourself.
That's really important. Basically, we should all be thinking of
the marginal social costs and the marginal social benefits when
we're deciding whether we should wear a mask. But that
can be for everyone to do.
Yeah, the result is that there are folks out there
who choose not to wear a mask, who would if
they were fully considering the benefits to others. That doesn't
mean everyone should wear a mask, just that there are
some people for whom it's not worth it to them,
but it would be worth it if they considered all
the total benefits to others. The end result is that
as a society, we just don't do enough of these
activities that have positive externalities, like mask wearing, because we
tend to underestimate or undervalue the total benefits to everyone
else when we make our individual decisions.
And social norms can help though. In a lot of
East Asian countries, it's pretty normal and even expected to
wear face mass when you have the cold or a flut,
and these countries have had little trouble convincing people to
wear masks as it's already part of their culture. They've
had many years of practice with mask wearing.
That's true. The thing is we don't want to have
to rely on the goodness of people's hearts or to
wait for huge shifts and social attitudes. There are certain
things we can do right now to encourage activities which
have positive externalities. One of the main things governments often
do is to give subsidies is these increase the amount
of something will purchase or use. We looked at subsidies
in our previous episode on government intervention. In the case
of masks. An example of a subsidy would be to
give people money to buy a mask or to provide
them for free. This is exactly what France did at
the peak of the coronavirus pandemic.
You know, the big idea is that there are benefits
that are accruing to other people that you're not taking
into account. So if I'm a government, what I want
to do is try to get you to act as
if you were taking those benefits into account. A subsidy
gives you a private benefit that you know it's roughly
equal to the benefits to others, then you'll make decisions
that are more socially optimal.
There can also be rules which change your own private
cost and benefit calculation, or you know your pro and
con list, that will help get more people to make
the best decision for society. For instance, a lot of
states and cities in the United States required people to
wear masks in shops and public transit during the pandemic,
or else they'd risk a fine, or they wouldn't be
allowed on the train.
There are examples of using both approaches at the same time.
The big ideas we want people to make better decisions,
decisions that take into account the benefits to others, and
so some stores said, look, I really need you to
wear a mask to come in, but we'll also give
you this mask if you come without one. So in
this case, the stores used a rule about mask wearing,
but they also provided the masks too, as a type
of subsidy.
We also have negative excellent, which is when other people
suffer due to something we do or consume.
You know, if you smoke, you face costs in the
form of bad consequences for your health, but you'll also
you know, I guess benefit from if you enjoy smoking cigarettes,
But society as a whole suffers a whole lot more.
First off, strangers have to breathe in your smoke if
you're in a public place, and they can get seriously
ill and even develop cancer as a result of your
cigarette smoking. Second, smoking is bad for your health. If
you get ill, well, you'll need health care. So all
taxpayers might have to pay to deal with the health
consequences you'll pay due to your decision to smoke. This
is tax money that could be spent helping other people.
Also, a lot of environmental issues are about negative externalities.
We mentioned driving and how exhaust fumes lead to climate change.
Yes, you know the thing is, if I'm driving my
car here in ann Arbor, Michigan, Well, the exhaust fumes
will not only be bad for the air quality in
ann Arbor, but for the whole of Michigan, even the
whole of the United States and the entire planet too.
Yes, because we don't have barriers in the sky which
keep car emissions confined to a small area.
Yeah. So the problem with negative externalities is that we
don't fully account for the costs of our actions on others. Therefore,
we often engage too much in activities which have negative externalities.
We need to use strategies which will decrease our demand
for such products and activities, strategies that help us face
the cost that the plant is facing.
So I'm thinking of some ways to get us there.
Cigarettes are taxed heavily in many countries, and if you
tax something, you end up with less of it, So
taxes tend to reduce consumption. Also, a lot of countries
have banned smoking in public places to deal with the
negative externality of non smokers having to breathe in secondhand
smoke and risk illness. Ireland got their first and they
band smoking in workplaces in two thousand and four.
We have pretty strict rules about smoking indoors in Australia too,
and bans exist in Spain, Turkey, Canada and many other countries.
But to keep track, so far, we've talked about two
ways to deal with negative externalities. You can tax the
bad things, you can ban the bad things. So in effect,
rules and regulations exist to limit activities with negative externalities.
You know, we keep mentioning the environment. The science is
clear that carbon emissions contribute to climate change. Most economists
think we should deal with climate change by putting a
price on the negative externality, which is carbon. By putting
a price on carbon, we then take it into account
when we make our everyday decisions, like if we should drive.
The idea about pricing carbon is it causes people to
take account of the cost of carbon on the environment,
and that not only leads to better decisions today about carbon,
but it creates an incentive to find other solutions to
the carbon problem. When carbon's expensive, there are more opportunities
to make money by finding alternatives to environment to sh
drawing carbon use, so over time carbon use will fall
by even more.
Sometimes you'll also hear people talk about cap and trade,
where we use both regulation and prices to try to
get to the right amount of emissions.
The cap part sounds like you can only do so
much of something.
That's right, So the government will set up maximum quantity
for emissions, for example, and then let companies trade among
themselves to figure out who should actually cut their emissions.
So instead of the government determining how much each specific
company can pollute, it can let companies decide who should
cut emissions by allowing them to trade permits among themselves.
Permits allow the government to set the total amount of
emissions while also letting the market do its magic. The
idea is that new factories that can produce with very
few emissions can produce their goods more cheaply because they're
not going to need to buy as many expensive permits.
In fact, they may even auction off their permits and
make more money that way. In the end, the trade
aspect of cap and trade pushes old polluting companies out
of business in general.
The idea of pricing negative externalities is that we want
to harness market forces to help create the incentives to
reduce those externalities. We get some of this with cap
and trade, but I prefer carbon taxes. When we tax something,
we end up with less of it, and that's what
we want with negative externalities. That also means that it's
a really good way for the government to raise money.
Let's be realistic. Governments need to raise money, so if
they tax externalities, they don't have to tax other things.
So much.
So externality seem to mean that the market doesn't always
get us to the right outcome because people don't pay
enough attention to the effects of their actions on others.
Yes, this is a form of market failure. Externalities are pervasive.
The real question is how big are they. The externalities
from carbon are big and important and will affect future general.
Although what of Justin's favorite negative externalities is small and
not that important. It's farting in an elevator.
Hey, that's my cabin emissions right there, But I don't
do it because people would give me dirty looks. So
you see, there's a potential negative externality and we've figured
out the way to solve it by social norms.
The key idea is that governments can help us take
into account the costs are benefits that we're imposing on
other people with externalities by using taxes, subsidies, or rules
and regulations.
So what can we think about to really understand this
concept of externallyities.
Open the next few days, just think about each decision
you make in the many different ways in which your
actions affect others, and think.
About whether you would make a different decision if you
were taking into account the full set of costs or
benefits that you're having on other people. And then, you know,
think about the role that government or society is playing
and trying to push you to make better decisions for everybody.
Let's see, justin, I'm gonna I'm gonna see how my
actions impact everyone else the next few days.
Well, for us, it's always a positive externality being with
you as hey.
Justin, remember not to fart in an elevator this week.
I don't. It's an example, a teaching example.
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