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Wednesday, February 29, 2012

Conceptual errors lead to externality abuse

In class, we discuss how there is a lot of externality abuse in politics, as well as things being called public goods that are not actually public goods from an economic standpoint. Conceptual errors are a big part of why these abuses occur: People do not understand what an externality, market failure, or public good is from an economic standpoint, yet try to analyze it through economics.
For example, people often consider the government a market, rather than a force used on the market, and then consider externalities created by the government an externality, and a source of market failure. But the government isn’t a market; it’s a force. It’s a failure of the government if something they do creates an externality. For example, in a blog I read they talked about how taxing sodas is a good idea because they create a negative externality, because they are unhealthy and can increase medical costs for the person drinking them. They claim it’s a negative externality because taxpayers pay the cost through Medicare/Medicaid. However, these programs are created by the government, and only because of these programs, is there a 3rd party that is affected. However, Medicare/Medicaid are government created programs, and if they didn’t exist, there would be no externality; if someone was unhealthier and paid higher medical costs because of all the soda they drank, they would pay the costs themselves. This is a government failure, not the market failure; plus, the government intentionally involves the 3rd party through taxes, so it does not meet the definition for an externality.
Another example of this conceptual error is health insurance, and how it’s getting more expensive and less people can afford it. There is a lot of regulation in place limiting competition between healthcare insurance companies, which plays a role (among other things) in increasing healthcare costs. However, these regulations are in place by the government, not the market, and therefore that is a government failure, not the market.
Another example of a conceptual error is in public goods. Public goods must be both nonrival and nonexcludable to be true public goods. Some examples in class we talked about were highways and roads, and how these are club goods, not public goods. Another example is parks; they are congestible, and so have a limit of nonrivalry. Also, they are excludable, because you could charge a fee to use the park rather than have them open to the public. The government uses taxes to build parks because they consider them a public good: trees are good for our air and environment, they are good for activity of the people who use them, but these are not third parties that are benefiting unintentionally. They pay taxes for these parks, the government intends to make things better for the society as a whole, therefore intentionally involving the third party (even if they don’t pay taxes), and so it does not fit the economic definition. Just because the park does positive things for people (therefore it is good for the public) does not make it a public good; the government uses force to by choice provide them free of charge. Technically, parks, highways, education systems, and many more things are actually club goods, and club goods can be provided by the market, providing they can get efficient membership, provision, and utilization over time.
By assuming government failure is market failure, many people see externalities or other sources of market failure everywhere, and say that this is cause for government action. Whether the externality is negative or positive, if it is created by the government, it is not a market failure. By economic definition, if it is not a market failure, the government should do nothing; so in the case of externalities caused by governments, governments should stop acting. 

Danielle Pierson

Dr. Anthony B. Bradley, in his article "Corn Subsidies at the Root of U.S.-Mexico Immigration Problems" (Available at http://www.acton.org/pub/commentary/2012/02/29/corn-subsidies-root-us-mexico-immigration-problems), makes the claim that many of the problems associated with immigration are associated with the subsides that our government grants to farms. Bradley references a study my Dr. Seth M. Holmes that compares the US national minimum wage of $7.25 to Mexico's minimum wage of the equivalent of $4.60, and that 95% of US agricultural workers are Mexican immigrants, and that 52% of that number are undocumented.

Obviously, those percentages show that there are heavy incentives for Mexican laborers to immigrate--legally on not--to attain jobs in the US, especially when you consider other information presented in the article: this group of people suffers from increased rates of illness, chronic conditions, malnutrition, and other health problems. What would incentivize a worker to incur these risks, as well as the risk of deportation, the dangers inherent in crossing the border illegally (dehydration, detention, being shot outright), as well as the loss of community and connection their families?

The $22.7 Billion in remittances that Mexico's central bank recently announced likely have something to do with it. The Mexican government claims that NAFTA, and specifically, the massive subsides that the US government hands out to domestic corn farmers are a large part of that problem.

Now let's examine the effect that those subsides would have on international trade:

First, they would stimulate the production of more corn than the undisturbed market would. This overproduction of corn would result in a surplus in the domestic market, driving down the prices of both domestic and exported corn.

Second, when translated into an international market, the low price of American corn results in a price floor in the Mexican market, effectively leading to a shortage of production there when Mexican corn farmers (most of Mexico's agricultural sector) are unable to produce corn at the prices that are effectively set by American imports.  It seems obvious, when viewed economically, that Mexican farm laborers, put out of a job by artificially strong production, without other skills or the means to attain them, would decide that it was worth the hazards of crossing the border illegally, suffering more ailments, working as a part of a social system that they don't belong to, in poor conditions, in order to send money to their family so that they can afford to buy cheap American corn.

It seems as though the US government paid nearly $20B in direct subsidies to farmers last year, and, by so doing, hemorrhaged $22.7B out of our economy. As these subsidies were designed to shield US crop producers from the effects of bad years and competition with foreign markets, I believe that they are improperly designed and implemented. Rather than helping the market allocate labor resources effectively or produce efficient quantities of corn, they have spurred further inefficiency on a global scale, as more corn is produced in areas that are not well suited to it, and more health and risk expenses are moved onto laborers, and on a national scale, a significant portion of the money earned in the local economy is remitted to foreign consumers.

Endangered Pristine Hoback River


A conservation group listed the Hoback River as one of most endangered rivers in the United States, saying it faces the threat of pollution from a proposed gas field in the Noble Basin area of the Wyoming Range.  The proposed gas field sparked my interest to investigate any possible market failure; sources of market failure are everywhere.  The article was more intriguing to me because this river was recently listed on the endangered list and is near my hometown.

“Listing the Hoback this year was a no-brainer,” said American Rivers northern Rockies director Scott Bosse. “It’s one of the most pristine rivers in the country, and it faces an immense threat from oil and gas drilling.”  The marginal social benefit of drilling next to an endangered river leads me to question pareto optimality and individual ethic in order to see if we have efficiency or room for a pareto improvement. 

“I can’t think of another case in the United States where industrial-scale gas drilling has been proposed at the headwaters of a Wild and Scenic River,” Bosse said.  It looks like in this case the individual ethic controlled the marginal social benefit in order to outweigh our social cost; therefore there is inefficiency in this proposal that clearly developed into an externality.  In particular, officials at American Rivers worry about the impacts of a proposal by Plains Exploration and Production Company to drill 136 gas wells immediately south of the river. Runoff, a spill or contamination of the aquifer could channel pollution from the gas field directly into the Hoback River’s headwaters, Bosse said.  To identify our externality here we must understand the three elements of an externality.  First the action must be unintentional, non-market and be done interdependently.  There is no spill over, no market.  Just a transaction between you two and the third person can’t be related through the market.  We also remember that an externality is a positive or negative, no dollar value assigned to it.  The people such as the PXP (Drilling company) making the transactions cannot always see the external cost.

“We think there is clear and present danger to groundwater resources and surface water resources,” he said. “We think that the Forest Service hasn’t fully considered what a worst-case scenario would look like at the Hoback headwaters.”  Negative externalities happen when law/rule is poorly defined.  Keep in mind that property rights are assigned to people, so no one individually can claim the river to fight the drillers. 

Smitherman said the issue is bigger than the lower Hoback’s Wild and Scenic designation. 

“It’s more fundamental than that,” he said. “It’s an important fishery, and any type of pollution at all could be devastating to that ecosystem.”  Again, when the rules/laws are loosely defined we run into negative externalities.  Externalities are a source of market failure so; the negative externality of the drillers spilling oil right next to the pristine river cause there to be inefficiencies in the quantity supplied and demanded of water, fish and the ecosystem.  This is because the marginal social cost doesn’t equal the marginal social benefit.  Very important to remember that the market of oil cannot fully capture the whole marginal social cost.  That being said, just because there is always a cost to drilling next to rivers doesn’t mean it is necessarily a negative externality.  We must ask if there is an external cost, and there clearly is with the pollution of the water, and the impact on the ecosystem that would have a ripple effect through the small community of Hoback leading to the presence of a negative externality.  Let’s recall that externalities don’t correlate with government, it relates to the drillers and their voluntary choices that lead to inefficiencies and ultimately market failure for many markets in the community.

Even though I don’t want to group externalities and government together, there is the possible role for government (force) in this situation of the negative externality.  The government is known well for using its force; therefore they could place a corrective tax on the drilling company for pollution per unit.  Actually, it wouldn’t matter whether the government places the corrective tax on the buyer or the seller of the oil; the corrective tax can help to regulate drilling and manipulate the market to reach optimal pollution.  You may think I'm crazy for saying optimal pollution, but there is always an efficient amount of something and that is no different for river pollution.  That being said, we will never have zero pollution or complete pollution abatement.  If no drilling ever happened then we would still have some pollution; Furthermore the marginal cost to control oil pollution abatement from the water is the opportunity cost of using resource to controlling the pollution.  Therefore, we are polluting through trying to control pollution, kind of a never-ending circle; this leads me to support my thought that there has to be an efficient amount of pollution for the Hoback River.  What they need to ask is what everyone’s marginal social benefit, or willingness to pay in order to reduce the pollution for their river and ecosystem.  When the benefit of the oil equals the cost of the pollution then you could say you have an efficient amount of pollution.  In this case though, they do not equal and the opportunity cost is greater to the community of Hoback than the benefit from oil.  The key is how we value our goods and services won’t allow for the zero pollution like they are asking for.  Even though they are willing to give up oil, they aren’t willing to give up all the oil.

So what can they do to help alleviate the tension, the government can tax it.  I previously brought up the idea of a corrective tax, but the government won’t ever do that so they could propose a different type of tax.  First, they would need to calculate the marginal external cost, which is not easy.  In general economist do this because they don’t like standards.  They want to find what it is at the margin and no the average so they can be more cost efficient.  So what they should do is operate through least cost by implementing either an emissions tax or a pollution tax.  They could tax per unit of pollution until they have the tax greater than the marginal cost to control.  This would ideally lead to less pollution.  When you can get the tax to be equal to the marginal cost of control then both sides could be happy and efficient.  Another option for regulating pollution would be to sale permits.  Unfortunately, pollution permits are marketable and we must stay strict on our exchange rates to regulate hot sports.  Scott Winters, vice president of corporate planning and communications for Plains Exploration and Production Company, said in an email. “PXP has not been contacted by American Rivers to discuss our proposed project or to offer a buy out of the leases.  As the Coase theorem suggest, an individual (drillers) must be held accountable or liable for their pollution to help prove the cause and effect.  “PXP is sensitive to community concerns about protection of ground and surface water quality in the area surrounding the project,” Winters continued. “PXP has taken extra steps as part of the Wyoming Range Conservation Agreement to design as many protections as possible for water resources in the area. Among other things, PXP has agreed to relocate two pad locations to create an additional buffer between the Hoback River and some of the drilling operations.”  With the accountability of the drillers and the internalized cost through market exchange, we can see that markets can fix externalities.  If the government warrants its force to override decisions for drilling companies/ implementing taxes then the market itself can/does fix the negative externalities it causes.

Tuesday, February 28, 2012

Can one man fix a sluggish economy?

The topic I’m concerned about here is the American economy. Right now news stations (Fox news) everywhere are focusing on the presidential candidates and how one of those men is going to fix a struggling economy (if they would just be elected to office). This is not a matter of which party one affiliates with, but rather an issue of actions’ each possible candidate would take once elected to office. Technically the U.S. is no longer in a recession and has not been for some time. There has been recovery, just at a slow rate. So what happens if the candidates continue to borrow money and continue spending thereby increasing the national deficient? Incorporating monetary and fiscal policies? Doing this will help if the country is still in a recession, but it is not. An example of fiscal policy is government spending (borrowing) to stimulate the economy, but there is only so much debt even a country can accumulate before it reaches the point of no return. Or what if taxes are raised to reduce the deficit spending? Or just taxing the rich? Raising taxes is not the way to win a political race nor does the percent of tax increase cover what is needed to supply an adequate amount of revenue. Taxing the rich is a silly idea because what does “rich” mean in the first place. If you mean people making over a million dollars, and if the millionaires did not
find a way around the taxes, then the lack of them around would prove to be no benefit. So far this does not sound like an “efficient” use of government resources (under a Pareto Optimal definition of efficiency). What about entitlement programs offered by government? Cutting
down on these programs would free a large portion of funding. To address the original question, no one man cannot fix the economy but can have a strong level of influence on it.

Can you imagine DAYS long commutes?


The above link is an editorial from The Economist Website explaining this particular author's method of internalizing the externalities that coincide with extreme traffic congestion in places like Beijing.  Maybe some of you have heard of the traffic jams in the city that can last for DAYS.  Since we live in Colorado, this kind of traffic is unimaginable.

As we have discussed in class, roads and highways are better described as club goods, one in which we pay license, registration and a myriad of other fees to use (legally).  The author of this article explains his solution in alleviating congestion: paying a toll.  However, the amount of the toll is based on the demand of the road at any given time.  In times where the demand is high and congestion is rising, the toll will shoot up, deterring those who are not able or willing to pay from driving at all.  Conversely, the toll lowers during lower demand times.  

The issue with roads in congested cities is of course that it is difficult and nearly impossible to create more roads (moving buildings and putting roads through private yards wouldn't go over well), so we are looking at a fixed supply.  For the market to become efficient, the price would naturally go up when the demand for the good goes up and vice versa.  The implementation of tolls mimics this, allowing for efficient utilization of the roads with people who have important trips to make more likely to use the road than the person who just wants to go to the store to go buy a bag of Cheetos.

Furthermore, the money made from tolls can go towards building a better public transit system.  Light rails, buses, trains, etc can help those to travel that can't afford to pay the high tolls, further reducing congestion.

Overall, I feel this is a viable policy.  It may hurt initially for those who are inconvenienced and must figure out cheaper and more efficient ways of getting around, but eventually the system will sort of smooth everything out, eventually benefiting everyone in the city.  While the concern is certainly whether or not government can do all of this efficiently without causing further transportation problems, I can't imagine it can become an absolute failure.  It has to be better than days stuck in grid lock.

We Are a Federal Republic, After All

In 1974 the National Maximum Speed Law was passed that prohibited speed limits above 55 mph. In the late 80’s the rules were eased and in the mid-90’s it was repealed. But how was such a law even passed? We are a Federal Republic, after all, and the Constitution grants limited powers to the Federal Government. The 10th Amendment drives home the point, giving the States any powers not given to the Federal Government. What they did was they told the States that failure to comply would result in a withholding of Federal funds for highway repair. In essence, “Do what you want, but we’re taking money away from your citizens and we’ll give it back to your state, but only if you follow our rules. If not, we’ll just keep the money.” So, the speed limits were changed.

This is just one illustration of how I believe the Federal Government has become more pervasive in our lives than what was intended at the founding of our nation. There are differing opinions about the role that government should play in our lives, and I’m not arguing that point. I do believe, however, that the Federal Government should play less of a role and that what role the state governments play should be up to each state and its citizens.

I watched the tragic events of Hurricane Katrina play out on television and wondered why the Federal Government was being blamed for not protecting the citizens of Louisiana rather the state itself. Perhaps it was because over the years, as the Federal Government increased its power in our lives, we, and the states, have become dependent on them. Maybe if the states had been given more independence, the state of Louisiana itself would have been more prepared and better able and willing to protect its own citizens.

I look at categories of Federal Government expenditures and wonder how much of a role they should have in them. Education, Housing and Community Services, and Transportation all jump out at me. States already do spend money themselves on each of these, particularly Education, of course. But I wonder, even so, if the Federal Government is more involved in these and others than is needed. 

Green energy subsides create ghost jobs

This week I read an article on the Wall Street Journal about the overestimations made by the government about the jobs that would be generated by the $10 billion stimulus given to renewable energy companies to expand their operations. In a study surveying many of the companies and communities recipients of the money injection, the results were far from the 2 to 4 million jobs projected by the President's Council of Economic Advisers. As a matter of fact, the net jobs were often negative after the stimulus package.
I'll leave the discussion of whether the Keynesian concept that an increase in Government spending serves as a catalyst for economic recovery through the multiplier aside and discuss the stimulus on efficiency grounds.

Unless there is a market failure associated with the matter, Government intervention will leave the market at a worse condition than previously. On this particular case, the President could argue that the reasoning behind the stimulus was based on the fact that there are externalities involved, and I think it could be a successful claim if the implementation and his message were different.The pollution generated by oil-based energy companies is definitely an externality, since it generates an unintentional non-market interdependency between market actors. If the government implemented a Deposit Refund System, where they impose a tax to reduce pollution, then they could in turn provide a subsidy for companies that are developing cleaner technologies. For this reasoning to be economically sound, I think that the Government would have to make it clear that they are not trying to create jobs through it but reduce pollution, and the money for the subsidies is coming from a pollution tax.

As it stands currently, the stimulus is not justified on efficiency grounds, since I don't see a positive externality on the creation of new jobs. Jobs create a market interdependence between actors, and the results are reflected on the wages paid to workers, so there is not a market failure involved here. Therefore, the disastrous results obtained by the package leading to the worsening of local economies does not come as a surprise.

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Monday, February 27, 2012

Externalities abuse

In this blog I'll focus on two quotes by Christina Romer from her article Do Manufacturers Need Special Treatment?

The author is talking about positive externalities of production clustering which brings more business into the area, and gives them better chances to succeed. Here is what she said?
"If the company that jumps in first and eventually succeeds reaps all the rewards, there’s not a market failure....
On the other hand, if an early entrant paves the way, but other companies come in later and snatch the rewards, government intervention could be helpful." She is basically saying that if private business succeeds, there is no market failure. However, if private enterprise fails (and it happens very often) then it's market failure and government should intervene. I don't think that it is a good definition of market failure. It simply means that if a private firm tried a business and failed, and later, firms that moved into the area become successful it's a normal business process of trial and error. It's not a market failure and thus cannot be justified for government intervention.

"Today, we face a profound shortfall of demand. That truly is a terrible market failure, and it warrants government intervention." This is the biggest joke of all times. That's the biggest lie of all times! But it looks that it was repeated enough times that a lot of people (and economists) believe it. The reason it cannot be true is because market failure can occur in one of three instances:
1. Externalities
2. Public goods
3. Market power (monopoly)

"profound shortfall of demand" is not an externality, because people are directly involved in it: for different reasons, they decided not to buy products and services which is their right. These actions were "market" and "intentional". So, it cannot be an externality. Obviously, it is not a public good.
Someone may argue that it a market power. I would object and say that it's not a market power, but rather a market process, the market itself. It's a voluntary process. If government intervenes to stimulate the demand in a specific area, then it will reallocate resources of production from other uses - less valued, according to the market. Unfortunately government cannot stimulate demand forever, without having to pay for it. Government (taxpayers) will have to pay for current consumption in the future, which will definitely create "profound shortfall of demand."

Gas Prices Rising in 2012

Source: http://community.nasdaq.com/News/2012-02/gas-prices-rising-in-2012-can-the-government-do-anything-to-stop-the-increase.aspx?storyid=122488

I will begin my first post stating I am not an economics major. I am pursuing a major in distributed studies that incorporates economics, politics, sociology and I am taking numerous business classes for my own purposes. I share this, because I believe the problem of regulating gas prices is a systemic issue, not a Cartesian one (i.e. Descartes approach of breaking something apart to see how it works).

Systems theory explains topics (people, problems, etc.) have interrelations with other topics. Affect one thing, and another is changed (positively, neutrally or negatively).  Economics attempts to make the best use of limited resources. To me, principles of management, politics, sociology, economics, technology (among a few) are at play. At times, I believe economists can be very Cartesian (possibly accounting for industry-wide nonconformity of opinion on specific topics).

I do not believe the U.S. government can do anything to regulate the prices of gasoline (with long term success). In a June 11, 2011 article, in the Colorado Springs Gazette (section B, page 11, titled “Saudis Ignoring OPEC, Will Up Oil Production”), the Saudi’s wanted to avoid a price crash (like the one in the second half of 2008 when prices were near $150 per barrel). Prices plunged nearly 70% from the record-high prices. The Saudi’s planned (against the judgment of OPEC) to release 1.14 million barrels (per day) into the economy (to make up for the shortages).

I believe gas prices are regulated by the OPEC monopoly. At times, rogue decisions are made (like the Saudi’s decision to self-regulate) for the successful continuation of business. In 2008, Americans chose to drive less (part of the reason for the 70% plunge in prices).

Economically, supply and demand issues are at play. In class, we covered negative externalities and corrective taxes (as a means of explaining gasoline pricing). Our equilibrium (intersection of marginal private cost and marginal social benefit) and optimal (intersection of marginal social cost and marginal social benefit) explains how a corrective tax can be used to derive optimal quantity and price for gasoline. With the OPEC monopoly, such corrective taxes do not exist (in as much as U.S. government intervention). OPEC’s economic models probably do not coincide with what the U.S. government can do to help regulate gasoline prices.

The article (top of this post) explains the U.S. demand for oil is about 80 million barrels per day. We can choose not to drive (indirectly causing regulation in OPEC policies), or be slaves to the prices set by OPEC. The government can play with tariffs and / or embargos, but who needs another Smoot-Hawley debacle. Gas prices, economically, are played out through supply and demand. Government intervention is, sometimes, more problematic than pragmatic.

Dan Baer

Saturday, February 11, 2012

The Solution to Some Externalities is in the Air

Today I was watching the movie Burlesque and it occurred to me that the central conflict of the movie was solved by considering externalities. For anyone who hasn't watched the movie (which I'm assuming many of you have not), the plot is essentially a small town girl begins to work at a burlesque club facing foreclosure. She dates a developer for a short period of time and learns about air rights. Finally, the day before the club is to be repossessed and that same developer is about to buy the club and turn it into a high-rise office building, she realizes that the owner of the club will be able to sell the air rights to a luxury condominium builder whose condo views would be obscured by the office building that would take the place of the club.

Though clearly a highly contrived fictional story, burlesque brings up an interesting point with regard to market solutions to externalities. Many non-economists seem to think that the only way to prevent externalities from occurring or reduce the effects of externalities is to have the government interfere. In this case the unintentional, non-market interdependence was between the builder of the luxury condos and whoever would own the space occupied by the Burlesque club. Should the high-rise office building be built in place of the burlesque club, the luxury condo builder would have a difficult time selling the condos in his building since the great view he expected would exist when he began construction on the building would be obscured.

The condo builder was able to trade the right to the air space above the burlesque club and keep the view for his condominiums clear for as long he owned the rights, thereby eliminating the market failure related to the externality of obscured views. In many cases defining property rights can allow for the prevention or elimination of externalities. Here, air space rights were defined and traded since views and lack of high buildings is valued in Los Angeles, at least by luxury condo builders and owners.

This lead me to think of a similar sort of situation that exists in downtown Colorado Springs. Zoning exists to prevent any builders from erecting buildings greater than 80' tall (limiting building height to approximately 8 stories). This is to prevent any building from obscuring the view of the mountains enjoyed by citizens and tourists alike. Zoning, however, is inefficient since it does not allow for market adjustments to the acceptable heights of buildings. All buildings have a set maximum height which is essentially a ceiling within the market model. Ceilings create shortages, and if the zoning restriction is the equivalent of a ceiling, the zoning policy creates a shortage of height inefficiency. This means that there is at least one person who is willing and able to pay an additional amount of money to construct a taller building.

Instead of simply limiting building height, the city could tax additional feet above the "efficient" height of different types of buildings, therefore causing the builders to internalize the negative externality of obscuring the view of the mountain. They could also choose to allocate the air rights to a certain level (not interfering with airspace use by comercial and military airplanes) above properties to the owners of the properties and allow the owners to sell the air rights separately from their property rights. By allowing the space above buildings to be traded separately from the buildings, you essentially commoditize views and allow the market to achieve the equilibrium balance of high buildings and unobscured views.

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