• Benefits and costs for other people will not affect the decision unless the benefits and costs for others matter to the actor.

Externalities, negative and positive

• Negative externalities are costs imposed on others that are not taken into account when making a decision.

  • Also called spillover cost or external cost.

  • Example: traffic.

• Positive externalities are benefits from an action that the decision maker does not take into account.

Perfection is unattainable

• Negative externalities cannot be completely eliminated.

  • This is because of transaction costs, which rule out a lot of wealth-enhancing exchanges that would otherwise occur because the cost of gathering information is higher than the benefits received.

  • Example: Roger's motorcycle in the mornings.

• Internalizing an externality is when the actor finds out about the consequences of his actions, takes the externality into account and chooses to alter his behavior.

• In industrialized society, negative externalities will multiply rapidly.

  • Civil people learn to ignore these externalities.

  • The first step toward containing the problems created by externalities in cultivating empathy, courtesy, humility and tolerance.

Negotiation

• Our everyday procedure for minimizing negative externalities is negotiation.

  • It produces mutual gains from exchange.

  • "Work it out for yourselves"

• When people aren't required to negotiate, they often adopt positions that are costly to others.

  • Example: demand no smoking laws instead of simply moving away.

• Negotiation cannot be effective unless property rights are adequately defined.

  • Voluntary exchange works well when all parties involved agree on who owns what.

Reducing externalities through adjudication

• Adjudication: a process for deciding who has which rights.

  • A resolution that discovers who has which rights.

  • The question of ownership is answered by investigating, not by choosing.

  • It aims at maintaining the continuity of expectations.

• Adequately defined property rights are not a sufficient condition for successful negotiations, but they do seem to be a necessary condition.

• Property rights that might once have been clearly defined can become vague when circumstances change.

  • When property rights become incompatible, adjudication is a way of settling the conflict.

The case of the complaining homeowner

• Example: Rita lived next to an airport, which created pollution (read the book for the example).

• Externalities are all over, should we correct them all?

  • That's impossible because there are too many spillovers.

The importance of precedents

• Example: Rita is most likely to not receive compensation.

• Expectations indicate the respective property rights.

• Adjudication tries to resolve conflicting claims by discovering existing rights, avoiding unexpected decisions or outcomes.

  • It tries to settle disagreements by reinforcing expectations that are most widely and confidently help.

  • Adjudication is this an effort to maintain the continuity of expectations in the presence of changing circumstances.

The problem of radical change

• When changes are so sudden, adjudication can't work because it is evolutionary.

  • In these cases, other rules may be required.

• Example: when we begin to place a higher marginal value on blue skies and clean air, we start to think of them as our right.

Reducing externalities through legislation

• Legislation: the creation of new rules.

  • It creates changes in prevailing property rights, and changing the rules of the game always raises the question of fairness.

• The challenge is to legislate in ways that avoid gross injustices.

• Many of the social problems that we call "pollution" can be analyzed as the product of negative externalities.

  • Command and control: legislation of physical restrictions, a popular approach to the problem of pollution.

  • This approach fails to minimize the cost per unit of pollution reduction

Minimizing costs

• Read the book for this example.

  • Gov orders factories to lower emissions by x amount.

  • Each unit of pollution emitted has a cost.

  • The total cost of reducing emissions goes down as more burden is placed on the factory with the least cost.

• Fairness is an important criterion for the evaluation of government decisions.

Another approach: taxing emissions

• The polluters themselves know the actual costs of reducing emissions, but the gov does not, so the polluters can exaggerate costs.

• When the gov doesn't have this info, it can impose a tax per unit of emission and then allow each party to respond as it thought best.

• Taxes on pollution have acquired the derogatory label of "licenses to pollute", which sounds like official permission to commit crimes.

  • Most pollution should be viewed as a cost, not a crime.

Efficiency and fairness

• Some people also object to taxes on pollutants because they think they're unfair, by placing the burden on the poor and allowing the rich to pollute.

  • They say rich people can afford it, and therefore it doesn't affect them.

• The efficient solution can be achieved while the issue of fairness can be settled in different ways.

• Comparative advantages can be exploited through exchange.

  • Factories with higher costs of reducing emissions can pay factories with lower costs to reduce emissions on their behalf.

The bubble concept

• Enforcement agencies can permit factories to exceed the limits at one point if they could make it up at another point.

  • Emissions rise when their control is costly, and then reduced when the costs lower.

• Firms could also be allowed to buy and sell "rights to pollute"

  • Firms with more emissions can buy these rights, so the total amount of emissions stays the same.

• By accepting and clarifying these rights, the gov allowed a market to evolve.

• Firms are also enticed to find ways to reduce pollution if they can sell the rights to someone else.

Rights and the social problem of pollution

• Pollution is a major and political concern because people disagree about rights.

  • "You are obtaining your benefits by imposing this cost on me but you have no moral right to do so, and therefore should have no legal right"

• Principles to help clear air pollution

  • Demand is never completely inelastic, we must decide how much we want

  • We should leave people as much freedom as we can for them to choose their own ways of adapting

  • We should keep in mind the importance of stable property rights

Traffic congestion as an externality

• Traffic congestion is consistently ranked by Americans as one of the most pressing problems of urban life.

• Driving without having to pay a toll is best for each of us but very costly for all of us.

  • Economists call it congestion pricing.

  • If we were required to pay fees based on the costs our driving imposes on others, we could eliminate congestion.

• Tolls are not used because people are hostile to the idea of it.

Once over lightly

• The actions that people take often impose costs on others that the actors do not take into account. Economists refer to these as spillover costs or negative externalities.

• Negative externalities multiply rapidly in urban, industrialized societies. When where the spillover costs of a particular action are greater than the benefits to the actors, transaction costs will frequently prevent people from negotiating more satisfactory arrangements.

• Negotiation is the standard procedure used by members of a society to secure the cooperation and consent of others without imposing unwelcome costs on one another. Clearly defined property rights make negotiations easier by lowering transaction costs.

• Conflicting claims of right can often be resolved by examining established principles and practices. Adjudication in this manner preserves the continuity of people's expectations. Unclear property rights and arbitrary changes in these rights make social cooperation more difficult by making it harder for anyone to plan with confidence.

• Rapid or radical social change may make it so difficult to resolve conflicting claims of right through adjudication that legislation is called for. Legislation entails the creation of new rules to establish and define what people may do with the resources at their command.

• New rules will produce lower-cost resolutions of such negative externality problems as pollution if the rules make it easier for people to exchange rights and obligations. Taxes on undesired spillover costs and systems for trading pollution rights provide appropriate incentives to polluters and facilitate low-cost arrangements to reduce pollution. So-called command and control approaches, by contrast, pay far less attention than do market-oriented systems to the information and incentive problems that challenge any policy aimed at reducing pollution.