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CONTROL EXTERNALITIES
DEFINITION: UNINTENDED SIDE IMPACT OF AN ACTION
BAD – “NEGATIVE EXTERNALITY” – POLLUTION
GOOD – “POSITIVE EXTERNALITY” – EDUCATION
PROBLEM OF AN EXTERNALITY
ENTITY CREATING THE EXTERNALITY DOESN’T FACE THE FINANCIAL COST OR BENEFIT FOR IT
FOR A NEGATIVE EXTERNALITY – DOESN’T PAY THE COST
FOR A POSITIVE EXTERNALITY – DOESN’T RECEIVE THE BENEFIT
PROBLEM OF AN EXTERNALITY (CON’T.)
RESULT:
TOO MANY PRODUCTS/SERVICES WITH NEGATIVE EXTERNALITIES ARE MADE
TOO FEW PRODUCTS/SERVICES WITH POSITIVE EXTERNALITIES ARE MADE
ONE SOLUTION – NEGOTIATION
SPARKS FROM TRAINS IN 19TH CENTURY CREATED FIRES IN NEARBY FARMLAND
RAILROAD AND FARMERS NEGOTIATED – FARMERS PAID FOR SPARK RETARDANT EQUIPMENT ON TRAINS
SMOKER AND NON-SMOKER CAR-POOLING – MAYBE SMOKER PAYS FOR GAS
RESULT DEPENDS ON WHO HAS “PROPERTY RIGHTS”
BUT NEGOTIATION OFTEN DOESN’T WORK
WHEN LARGE NUMBERS OF PEOPLE ARE IMPACTED
BEST SOLUTION: TAX THE ACTION GENERATING THE NEGATIVE EXTERNALITY, WHERE TAX EQUALS COST OF HARM DONE
SUBSIDIZE THE ACTION GENERATING THE POSITIVE EXTERNALITY, WHERE SUBSIDY EQUALS VALUE OF BENEFIT DONE
EXAMPLES OF SUBSIDIES
SUBSIDIZED FLU SHOTS – I’M LESS LIKELY TO GET THE FLU IF OTHERS ARE IMMUNIZED
SUBIDIZED EDUCATION – I BENEFIT FROM OTHERS BEING MORE ECONOMICALLY PRODUCTIVE – MORE SPENDING OPPORTUNITIES, OTHERS PAY MORE TAXES AND REQUIRE LESS FROM THE GOVERNMENT
EXAMPLES OF TAXES
CIGARETTE TAXES – SECOND AND THIRD HAND SMOKE MAY BE CONSIDERED A NEGATIVE EXTERNALITY BY MANY PEOPLE
ALCOHOL TAXES – TO “TAX” USERS FOR INCREASED LIKELIHOOD OF UNSAFE BEHAVIOR (TO OTHERS) AFTER DRINKING
A NEGATIVE EXTERNALITY TAX THAT HAS BEEN PROPOSED
CARBON TAX: TAX ANY ACTIVITY THAT EMITS CARBON AND POTENTIALLY POLLUTES THE AIR AND LEADS TO ATMOSPHERIC WARMING
-- DRIVING -- POWER (ELECTRICITY) USE IF POWER IS GENERATED FROM A FUEL EMITTING CARBON
ONE ISSUE WITH A NEGATIVE EXTERNALITY TAX
WHAT TO DO WITH THE REVENUE?
EITHER: * USE TO MITIGATE THE HARM DONE BY THE NEGATIVE EXTERNALITY * RETURN TO USERS SO FINANCIAL POSITION NOT HARMED
DON’T USE FOR SOMETHING UNRELATED TO THE POLLUTANT
TAX/SUBSIDY APPROACH TO EXTERNALITIES AND FREE CHOICE
FREE CHOICE STILL PRESERVED, BUTNOW CHOICES CREATING NEGATIVE EXTERNALITIES PAY THE COST, AND CHOICES CREATING POSITIVE EXTERNALILITIES ARE REWARDED
PROBLEMS WITH THE TAX/SUBSIDY APPROACH TO EXTERNALITIES
MEASURING THE COSTS FOR HARM FROM NEGATIVE EXTERNALITIES AND THE BENEFITS FROM POSITIVE EXTERNALITIES * MAY VARY SIGNIFICANTLY BETWEEN PEOPLE (EXAMPLE – AVERSION TO CIGARETTE SMOKE) * IN SOME CASES, OUTRIGHT REQUIREMENT OR PROHIBITION IS BEST APPROACH MANDATORY SCHOOLING TO AGE 16 PROHIBITED SMOKING ON PLANES
VARIATION ON A THEME – “CAP AND PERMIT” FOR POLLUTIONTHREE STEP PROCESS
1. EXPERTS DECIDE HOW MUCH POLLUTION IS ACCEPTABLE
2. SELL PERMITS TO POLLUTE BASED ON ACCEPTABLE LEVEL
3. ALLOW PERMITS TO BE TRADED
HOW FAR TO GO WITH EXTERNALITIES?
SHOULD CONSUMPTION OF CERTAIN FOODS LINKED TO OBSEITY BE TAXED AS A NEGATIVE EXTERNALITY?
* WHAT IS THE NEGATIVE EXTERNALITY – IMPACT OF OBSEITY ON HEALTH CARE COSTS, SO EVEN “FIT” PEOPLE PAY HIGHER COSTS FOR DOCTORS & HOSPITALS?