Monday, October 24, 2005


Someone Should Have Their Market Externalities in a Scrunchie Over This

The Author had intended to continue writing about stock options this week, but a disturbing article in the New York Times, “Poor Nations Are Littered With Old PC's, Report Says”, October 24, 2005, caused the Author to write a piece on market externalities[i]. The textbook definition of an externality is where an economic activity has costs or benefits that are not incurred by the people involved in the economic activity. Externalities are used in many modes of analysis, but the two that everyone would recognize are negative externalities and positive externalities. Check out these examples:

Negative Externality. Pollution is the poster child of a negative externality. Let’s use the example of a steel plant from the 1950s. A steel plant produces soot and polluting gases in the process of making steel. The gas causes lung problems and the soot is deposited in the areas adjacent to the plant. People get sick from the fouled air and the soot requires frequent cleanup. The steel plant has created market externalities. What the steel plant has done is shifted part of the cost of steel production onto its neighbors. In an efficient market, all of the costs of steel production would be borne by the steel producer.

Environmental laws and regulations are attempts to reallocate the costs of production and make producers pay the full cost of production. So when environmental regulations are scaled back, what is really happening is politically powerful producers are shifting their costs of production to others.

Positive Externality. A positive externality occurs when people that did not participate in the economic activity gain some benefit. Commonly-used examples from the Author’s healthcare economic days are vaccinations. Many, but not all, people get vaccinations from common contagious diseases such as polio, small pox, and measles. Usually children are vaccinated and the parents or health insurers pay the costs. But sometimes adults get booster vaccinations when they travel overseas. From an economic perspective, the economic actor in the transaction pays some money for the medical services.

The unvaccinated individuals also benefit when others are vaccinated. This is because the unvaccinated are less likely to be infected with the disease if a large number of the population is vaccinated. Consider that if you are unvaccinated and everyone else in your area is vaccinated, then there are few if any people who could carry the disease to you.


When doing research for this post, the Author found a couple fun examples of positive market externalities. [ii] Perfume was cited as one example of a product that can have both positive and negative market externalities. Perfume manufacturing can have negative externalities such as pollution. But perfume use may also have positive externalities if people near the perfume wearer smell the perfume and find pleasure in the wafting perfume. Similarly, a person who plants a flower garden will probably provide positive market externalities to those who view the garden and find pleasure in the visual delight.[iii]


It is difficult for the Author to understand why many conservatives are so rigidly opposed to strong environmental regulation. Pollution, greenhouse gas emissions, other nuisances result from negative market externalities. Producers or service providers, intentionally or unintentionally, are outsourcing their costs of production onto somebody else. Paying the full bill should be a matter of financial responsibility, good citizenship, a matter of presenting one's self as a supporter of law and order.

Economists look at externalities in terms of economic inefficiency. Would it cost more to clean up the pollution than prevent it? The more efficient solution would be the one that costs less AND allocates all costs onto the producer. But history and analysis shows us that it is almost always less costly to prevent rather than clean up pollution. Regrettably, many dirty industries have discovered it is even cheaper to bribe, uh, uh, make large contributions to the campaigns of, congressmen, senators and administration officials to weaken pollution rules rather than prevent pollution.


[i] Subscription may be required. PCs and monitors are toxic waste. Monitors contain as much as 8 pounds of lead. Chips, motherboards, cards and other components also contain toxic metals. See also the Basel Action Network, This group monitors compliance with the Basel Agreement that seeks to limit “trade” in toxic waste.
[ii] The Author does some research for his posts so he will be apprised of the latest issues on the respective topic. The Author believes that his readers are entitled to the best product he can produce. If you are taking time to read this, the Author believes your time should be well spent.
[iii] Locker room check. Perfume and flowers are okay for chicks and stuff, but real he-men, thug type healthcare economists don’t care about such sissy stuff.