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Sunday, May 13, 2007

Acid Rain- a Silent Agitator

Acid rain- is it really an externality?

An idea of an unintentional market interdependence in the form of a spilled cost onto a third party as a result of a market interaction between two other entities is very tempting to embrace. But is acid rain really an externality? And if it is, could there perhaps be something we never hear our colleagues speak of? If there is a market interdependence in the case of crime (such as the market for insurance) and crime is then not considered a negative externality, could we find such markets in the case of acid rain?

It is clear the “primary market” exists- a supplier of energy through coal burning interacts with the consumers of electricity as a result of the derived demand for coal. Hence, there is an initial market. Then let’s assume that some of the byproducts of electricity production cannot be sold in the market and the producer is disposing of them in the least costly way (blow them out of the stack). Due to the tall stacks of this factory (perhaps as a result of government regulation), the chemicals released are being transferred to a different location (area B), and descend back into the atmosphere via the harmful acid rain (or some other objectively harmful phenomenon).

So it seems, because of the production of the economic “good” such as electricity, we produce an economic “bad” such as acid rain. Unbeknownst to the residents of area B, they suffer this economic “bad” in a form of an acid rain that causes property damage to residents of area B. My first question: are these “negative externalities” captured by any market at all? In the case of acid rain, a market for property insurance will capture the damage. So can the pollution that caused the acid rain and subsequently property damage still be classified as a negative externality? Whatever the answer, is there anything else to it?

For simplicity purposes, let us assume 100 residents hold property in area B (each owning only one house). If 35 houses sustain measurable damage attributable solely to long-run effects of the acid rain, the insurance rates for the entire area will rise. Therefore, the house owners who are currently the customers of the insurance company will now have added costs associated with added risks (that is perhaps another justification how acid rain is not a negative externality). This suggests more individuals will realize the “status quo” of their neighborhood with regard to acid rain. Thus they will consume more insurance because of the higher probability of being rained on. Notably, it is an example of adverse selection.

Finally, as more residents of area B consume the insurance, as well as the increase in the quantity demanded by the current insurance customers in that area, they cast their dollar votes opting to be more risk averse. By casting their dollars in such a manner, they opt for insurance and opt away from consumption of alternative goods and services. Such pattern of spending money could lead to a reallocation of resources with ramifications extending into tempos of new capital formation, employment within insurance, other sectors of area B’s economy as well as certain political outcomes, the nature of which is quite uncertain and highly speculative due to the circumstantial details of this scenario.

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