The global positioning system (GPS) was originally developed for military purposes but has been made available to private companies since 2000. Allowing private companies to build new products and services using this technology has resulted in a massive increase in technological advancement in the US that provides significantly more economic benefit than the cost of operating the GPS system. Estimates place the value of GPS at $1.4 trillion from 1980 to 2019, but the federal government spends relatively little to operate the system.
Whenever an action creates a negative externality, the private individual allocates too many resources toward the production of that item. This happens because the producer is focused on their own profit maximization problem and is not accounting for any external costs associated with production. When it comes to meat packing or factory farming, producers don’t take into account the external costs of pollution or the potential risk of bacterial infection. Regulating such industries can mandate that firms take into account the social costs of production rather than the private cost of production.
Larry David is adamant about the unwritten rule of appetizer allotment. In this scene, Richard Lewis is also eating “too much” of the hummus that they have ordered to share. The “unwritten rule” is that the dish should be split evenly among the diners, but there is a strong personal incentive to eat more than your share. In a sense, this is similar to the tragedy of the commons. While it’s in the best interest of the group to split the resource fairly, some people may try to take advantage of the situation.
Thanks to Alex Marsella for the clip recommendation!
Individuals often make decisions that are in their own best interest, and often disregard the impact they may have on other people. Whenever this happens, individuals are creating an externality. Someone else either benefits or is harmed by that outcome. In the case of someone putting on deodorant, that could have spillover benefits from people getting to smell a “fresh scent.” If too much is applied, it could annoy others are turn to a negative externality.
This Turkish Airways ad shows the value of network externalities to a market. A network effect occurs when the value of a product or service depends on the number of users. Network effects are typically positive, such that the more people using the product, the more valuable the product becomes. Airlines are an example of network effects, as the ad points out, because the more places they fly, the more valuable the flights are to the people purchasing the tickets.
Tony joins his colleagues for lunch at a local pub to discuss potential leads for their newspaper, but he’s disturbed by a gentleman loudly munching on chips behind him. The man appears to be ignorant of the external costs he’s imposing on those around him and is focused on only his own satisfaction.
When people are unaware of the external costs they are imposing on others, they tend to overconsume, literally. Since there aren’t clear property rights, it’s not clear who should make the determination of appropriate volume. Tony could pay the man to stop eating his chips, but Tony may argue that the man should have to pay for the right to eat his chips so loudly. It’s harder to reach a solution without clearly defined property rights.
There appears to be a coverup of contamination of the local water supply by PG&E, but the impacts are becoming more visible. In this scene, Ed Masry meets with a PG&E lawyer to “negotiate” a settlement for damages causes by the contamination. While PG&E may not have believe their dumping was causing externalities, it appears that they may have imposed serious external costs on the region. One of the concerns of litigation of this sort involves determining the appropriate value of the reduced quality of life resulting from these external costs.
Thanks to Dawn Renninger for the clip suggestion!
Mumbai drivers are apparently notorious for honking, even when the light is red and people can’t move. The Mumbai police decided to incentivize drivers in order to reduce some of the noise pollution in the city. The police installed noise meters and if the decibel level reaches a certain threshold, the timer on the lights resets. A message flashes to let drivers know that the more they honk, the longer they wait!
Another fun policy intervention occurred in Europe to help drivers slow down.
Paladin is hired to settle an issue between a vineyard owner and a neighboring oilman. The smoke and runoff from the oil well are damaging the grapes of the award-winning vintner. This is a classic case of externalities and the Coase Theorem would suggest the two could meet and solve the problem on their own (if there were low transaction costs), but the Coase Theorem wasn’t written about until two years AFTER this episode aired.
This opening cartoon depicts Dre dutifully maintaining his castle and describing the lengths men go to in order to protect their castle. Unfortunately, we can’t always control what neighbor’s do with their castle and their decision to throw parties and disturb us is (seemingly) out of our control. The Coase Theorem would argue that so long as transaction costs are low, people should be able to bargain and sort out external costs imposed by private actions. The insinuation by Dre in this scene is that the transaction costs may be just a bit too high.
Clip recommended by James Tierney: