Externalities- Thank you sir, may I have another...

I buy a burrito because I like it

““The free market is for the good of The free market is for the good of everyone!”everyone!”

Selfishness is

for the good

of everyon

e

Workers make burritos for income

Owners open stores for profit

Farmers grow food to sell

The problem is that this doesn’t apply in every situation...

Case-in-point: DRIVERS

In a market transaction, both parties benefit:

I buy gas (makes me happy)

Gas station makes $ (makes them happy)

What about you? (unhappy from pollution and traffic congestion) This is a This is a “negative “negative

externality”externality”

The problem is, how can we make people pay for the damage they inflict on other people?

Pay More Money?USA: $100 Billion/Year in Vehicle TaxesBritain: $40 Billion/Year in Vehicle Taxes

It’s not a question of if people pay enough, rather that they don’t pay for the right things...

Marginal CostAverage Cost

High:•Licensing Cost•Cost of Cars•Cost of Gas

Low:•Extra trips don’t cost much more, even in terms of gas

***It’s also important not to get too caught up in the difference between a Prius and a Hummer. After all, the cars themselves don’t contribute to

pollution and traffic congestion...it’s the driving that does.

To solve this problem, let’s look at another similar issue and we’ll come back...

COLLEGE

College Campuses often have a huge problem with excess “partying”

Why does this happen?

Parties are expensive to throw, which leads (generally) to an entrance fee to

compensate for costs.

The problem with this is that an entrance fee is an “average cost”

which basically encourages people to get the most bang for their buck

= too much partying.

So then, our problem becomes a question of how to continue

partying (since colleges can’t stop it), but to discourage

excessive and unnecessary partying?

A couple of options:

#1 Raise the average (entrance) fee - This probably encourage less people to party, but would encourage heavier “partying” by those who choose to partake.

#2 Hire a better DJ - This would encourage more people to come and have fun without “partying” to excess.

#3 Raise the marginal fee - This would mean that each time someone partakes, they pay an additional cost and end up “partying” the perfect amount.

So now, let’s take this knowledge back to DRIVING:

Options for reducing driving:

• Raise Entrance Fee - Cars more expensive, fees higher, expensive gas.

• Hire Better DJ - Better buses, more subways, bike routes, PED-xing.

• Raise Marginal Cost - Externality charge for driving.

We have an answer, but not a solution. The question now

becomes how much to charge so that drivers take into account their

inconvenience on others, but to also not discourage efficiency.

Some issues:

#1 - Is this type of tax unfairly redistributive? (does it favor the rich over the poor in terms of % of income?)

YES, but this is the same for food, clothing, and houses; why not for road space and clear air?

**We cannot give out free food/clothes/houses because we run out. Does this mean we run out of road space because it is free?

#2 - Should rich people be able to pollute more?

YES, but rich don’t pollute because they enjoy destroying things, they are simply more able to. An externality charge would still make alternatives more desirable.

**Externality charges are simply more efficient. Think about an alternative voucher system where everyone was given 20 miles to drive per week. What would happen? (The poor (who value $ more) would likely sell their miles to the rich (who value driving more).

Can we create and ideal system?

• Charge for densely populated areas• Charge for CO2 Damage to Ozone• Charge SUVs for safety of others• Charge for weight/height inefficiency• Charge for congestion times• Charge for older cars

Now, we can calculate things like pollution and congestion, but can we really put a value on things like time? noise? road damage? accidents? delay?

Of COURSE we can! We already do...

• Avoiding a noisy area when choosing an apt? That’s a value on noise.

• Take a bus vs. a cab? That’s a value on time.

• Buy a smoke alarm for your house? That’s a value on safety.

Would this actually work?

• Not necessarily right away, but over time, ABSOLUTELY.• Small Changes: going to store, walking, bus internet.• Big Changes: 1/3 People change jobs every year (closer job) 1/7 People move every year (closer amenities).

• Domino Effect: If more people ride buses there is more street room and if there is more room, buses get everywhere faster.

• Carpools: Way to get to work and build relationships while also increasing parking and decreasing traffic.

Real-Life Examples:

• In 2003, London started charging about $9 a day to drive to the city center, a “congestion zone charge.”

• In 1 year: • car rides dropped by 1/3.• 15% increase in bus usage• 30% increase in bike trips• 25% avoided the city center• 55% increase in public transportation

“Abby Road”(in London)

Lastly, would this hurt GDP?

Ahem, there are also POSITIVE Externalities:

• If I paint my house and fix my garden, my neighbors benefit from a nicer-looking neighborhood.

• If Chance opens a sidewalk cafe for business, the streets are more pleasant.

• If Jessica Alba vaccinates her daughter, we are all safer.

• If Olivia Munn moves in next door to Mr. Martinez then life is good. (She likes video games -- I mean Chun-Li!? Score, bonus)