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Market failure in externalities

Logic_on_rails
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1/15/2012 3:36:24 PM
Posted: 4 years ago
Firstly, let me ask for civil discourse. Secondly, I note that I'm open on the issue and looking for intelligent discussion.

Now, externalities are essentially costs and benefits that private agents in a market do not consider in their decision making process. This is typically due to the fact that the price mechanism, which has high allocative efficiency (allocates resources well to meet consumer demand) , doesn't reflect certain side effects. As an exchange in a market economy can affect those other than are involved in the transaction we can see how negative externalities are a serious issue.

Obviously, the issue of positive externalities isn't an issue. We are focusing on negative externalities.

An example of a negative externality would be a company reducing freight costs by transporting goods by road as opposed to rail, which could result in substantial damage to the roads and add to noise and air pollution in more densely populated areas. In turn, this can lead to car damage, respiratory problems and so forth.

To put the above example in terms of supply and demand, the equilibrium price is higher and the quantity demanded lower under a social optimum vs. a market price.

Assuming the above holds true, what would happen is that individuals trying to do the most rational case of action for themselves would, on a larger scale, damage society as a whole - ie. The Tragedy of the Commons.

I look forward to a response.

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As a side note, I'm interested in discussing how the market provides for public goods (a good which once provided is difficult to prevent anyone from using, regardless of whether they pay) . Public goods are typically non-excludable and non-rival, which discourages markets providing these goods.

A similar issue is found with merit goods, those that have benefits beyond the individual who enjoys them directly.

I'd also like to hear feedback on whether a sepeate thread should be started on this topic. Feel free to PM me (although I'll need to accept a friend request first) .
"Tis not in mortals to command success
But we"ll do more, Sempronius, we"ll deserve it
Logic_on_rails
Posts: 2,445
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1/15/2012 3:56:11 PM
Posted: 4 years ago
Another point to consider is that although consumers may demand goods, humans are quite poor at determining what will maximise their utility (http://dunn.psych.ubc.ca...), and henceforth there could be grounds to deem consumer demand an inaccurate indicator of what should be demanded . This document makes a number of very interesting points about happiness and what people felt vs. expected to feel, and so I encourage people read it (it has relation to more than just this subject) .
"Tis not in mortals to command success
But we"ll do more, Sempronius, we"ll deserve it
mongoose
Posts: 3,500
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1/15/2012 10:27:19 PM
Posted: 4 years ago
At 1/15/2012 3:56:11 PM, Logic_on_rails wrote:
Another point to consider is that although consumers may demand goods, humans are quite poor at determining what will maximise their utility (http://dunn.psych.ubc.ca...), and henceforth there could be grounds to deem consumer demand an inaccurate indicator of what should be demanded . This document makes a number of very interesting points about happiness and what people felt vs. expected to feel, and so I encourage people read it (it has relation to more than just this subject) .

That was a very interesting read.
It is odd when one's capacity for compassion is measured not in what he is willing to do by his own time, effort, and property, but what he will force others to do with their own property instead.
mongoose
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1/15/2012 10:32:57 PM
Posted: 4 years ago
At 1/15/2012 3:36:24 PM, Logic_on_rails wrote:
Firstly, let me ask for civil discourse. Secondly, I note that I'm open on the issue and looking for intelligent discussion.

Now, externalities are essentially costs and benefits that private agents in a market do not consider in their decision making process. This is typically due to the fact that the price mechanism, which has high allocative efficiency (allocates resources well to meet consumer demand) , doesn't reflect certain side effects. As an exchange in a market economy can affect those other than are involved in the transaction we can see how negative externalities are a serious issue.

Obviously, the issue of positive externalities isn't an issue. We are focusing on negative externalities.

An example of a negative externality would be a company reducing freight costs by transporting goods by road as opposed to rail, which could result in substantial damage to the roads and add to noise and air pollution in more densely populated areas. In turn, this can lead to car damage, respiratory problems and so forth.

To put the above example in terms of supply and demand, the equilibrium price is higher and the quantity demanded lower under a social optimum vs. a market price.

Assuming the above holds true, what would happen is that individuals trying to do the most rational case of action for themselves would, on a larger scale, damage society as a whole - ie. The Tragedy of the Commons.

I look forward to a response.

----------------------------------------

As a side note, I'm interested in discussing how the market provides for public goods (a good which once provided is difficult to prevent anyone from using, regardless of whether they pay) . Public goods are typically non-excludable and non-rival, which discourages markets providing these goods.

A similar issue is found with merit goods, those that have benefits beyond the individual who enjoys them directly.

I'd also like to hear feedback on whether a sepeate thread should be started on this topic. Feel free to PM me (although I'll need to accept a friend request first) .

The best response to externalities is to privatize them as much as possible. If the roads were privatized, they could charge more to those who would be carrying heavier loads. If water were privatized, they would do everything in their power to prevent water pollution. Even with large rivers, you could have one company that manages the river and then sells it to people who utilize it. The more water a single person takes from it, they more they have to pay.

It's more difficult with air, given that you can't build giant bubbles to keep your own air. You'd also probably die from lack of oxygen. In that case, if it is efficient, the government should regulate emissions in some way. This is not a given. It can be more dangerous to have a government failure than a market failure.
It is odd when one's capacity for compassion is measured not in what he is willing to do by his own time, effort, and property, but what he will force others to do with their own property instead.
Logic_on_rails
Posts: 2,445
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1/17/2012 12:36:28 AM
Posted: 4 years ago
At 1/15/2012 10:32:57 PM, mongoose wrote:

The best response to externalities is to privatize them as much as possible. If the roads were privatized, they could charge more to those who would be carrying heavier loads. If water were privatized, they would do everything in their power to prevent water pollution. Even with large rivers, you could have one company that manages the river and then sells it to people who utilize it. The more water a single person takes from it, they more they have to pay.

It's more difficult with air, given that you can't build giant bubbles to keep your own air. You'd also probably die from lack of oxygen. In that case, if it is efficient, the government should regulate emissions in some way. This is not a given. It can be more dangerous to have a government failure than a market failure.

An interesting response.

I can see how privatising externalities can work in some cases, but there are other cases of note. For example, natural monopolies are those where competition is inefficient, typically because of the need for a massive amount of capital - ie. infrastructure. The reason I believe this type of monopoly could be better placed in government hands is accountability, assuming a structure where the people have some degree of influence (as with Australia, the USA etc.) .

One of the points to consider is that monopolies can, on occasion, raise their prices endlessly. Typically, were a company to raise prices enough, a new competitor could enter the market. However, were a company to have control over say, the water supply, nothing could be done (if there's a monopoly in IT for instance, somebody else can just enter the market) to prevent unnecessary price increases.

Also, I don't believe your response addresses the idea that more negative externalities could occur given a completely free market. I stated this previously:

"... in terms of supply and demand, the equilibrium price is higher and the quantity demanded lower under a social optimum vs. a market price.

Assuming the above holds true, what would happen is that individuals trying to do the most rational case of action for themselves would, on a larger scale, damage society as a whole - ie. The Tragedy of the Commons."

The point is that if markets aren't accounting for negative externalities when they inadvertently create them, then they are more likely to create more negative externalities (Ie. profit making is best served by methods which increase the number of negative externalities) , and more negative externalities can't be a good thing.

I look forward to a response.
"Tis not in mortals to command success
But we"ll do more, Sempronius, we"ll deserve it
RoyLatham
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1/26/2012 8:46:23 PM
Posted: 4 years ago
At 1/15/2012 3:36:24 PM, Logic_on_rails wrote:

Now, externalities are essentially costs and benefits that private agents in a market do not consider in their decision making process. This is typically due to the fact that the price mechanism, which has high allocative efficiency (allocates resources well to meet consumer demand) , doesn't reflect certain side effects.

I don't see the problem for markets. Many of the externalities are paid for by the government, and the government then turns around and charges users for the costs. For example, heavy trucks are charged huge fees for the wear they cause on roads. Extra fees are taxed on to goods to pay for the cost of disposing of them. Airline users are taxed for the cost of security screenngs. Hotel rooms are taxed by localities to cover the costs of city services provided to visitors. Government stays up late dreaming up ways to charge for externalities.

No doubt there are cases where externalities are not charged explicitly, and are ultimately born by citizens in general rather than the product consumers. The solution to that is to charge for them.

It makes sense to privatize as many of the externalities as possible. It the sae principle, that costs should be paid, but private enterprise is simply much more efficient. A good example is building a rail line. Private enterprise will seek to lower the cost by running it over vacant land as much as possible. Government will run it through a circuitous route through most expensive real estate. That's what gets support from the largest number of legislators.
RoyLatham
Posts: 4,488
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1/26/2012 9:00:50 PM
Posted: 4 years ago
At 1/15/2012 3:56:11 PM, Logic_on_rails wrote:
Another point to consider is that although consumers may demand goods, humans are quite poor at determining what will maximise their utility (http://dunn.psych.ubc.ca...), and henceforth there could be grounds to deem consumer demand an inaccurate indicator of what should be demanded . This document makes a number of very interesting points about happiness and what people felt vs. expected to feel, and so I encourage people read it (it has relation to more than just this subject) .

This is not a market problem. Making wrong choices is a problem of freedom. The main alternative is to have government make the decisions. How well does government do at that? Happiness is actually measured around the world (using polling data). The least happy places on earth are one with the most government.

The article doesn't mention that happiness rises strongly with wealth up until very basic needs for food, clothing, and shelter are met. After that the correlation is weak, as the article suggests. Liberals make an enormous mistake in supposing that a goal of society should be to equalize wealth. That doesn't make people happy, because once basic needs are met people are not significantly happier. The goal should be to get as many people as possible above poverty. Capitalism does that. Socialism provide equality in extreme poverty.