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 19 TH 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, BUT NOW 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 POLLUTION THREE 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?