Naval: An externality is where there’s an additional cost imposed by whatever product is being produced or consumed, that’s not accounted for in the price of the product. This can happen for many reasons. Sometimes you can fix it by putting the cost back into the price.
Some of the most ardent critics of capitalism argue it’s destroying the environment. If you throw away capitalism because it’s destroying the environment, then guess what—we’re all headed back to pre-industrial times. That’s not going to be a good thing.
Pricing externalities properly is more effective than feel-good measures
Because the environment is finite and precious, we have to price it properly and fold that back into the cost of products and services.
If people are wasting water, releasing hydrocarbons into the atmosphere or polluting in other ways, society should charge them what it costs to clean up the pollution and return the environment to a pristine state. Perhaps that price has to be very, very, very high.
If you raise the price high enough, you’ll knock out pollution. That’s much better than feel-good measures like banning plastic bags or restricting showers during a drought.
Properly pricing externalities can save resources in a tremendous way
California likes to run declarations and ads to scare people into avoiding showers during droughts. It would be better to raise the price of fresh water. The average consumer might pay a few pennies more for a shower; but the almond farmers—who consume a lot of water—will cut back and almond farming may move to a part of the country where water is more abundant.
Properly pricing externalities can save resources in a tremendous way. It’s a good framework to use when you want to do things like save the environment, rather than doing feel-good things that won’t actually amount to anything.
57 - Externalities: Calculating the Hidden Costs of Products
Wed, 31 Jul 2019
56 - Net Present Value: What Future Income Is Worth Today
Mon, 29 Jul 2019
55 - Consumer Surplus: Getting More Than You Paid For
Thu, 25 Jul 2019
54 - Price Discrimination: Charge Some People More
Thu, 25 Jul 2019
53 - Compounding Relationships Make Life Easier
Fri, 19 Jul 2019
51 - Negotiations Are Won by Whoever Cares Less
Mon, 15 Jul 2019
50 - Schelling Point: Cooperating Without Communicating
Fri, 12 Jul 2019
49 - Kelly Criterion: Avoid Ruin
Wed, 10 Jul 2019
48 - Principal-Agent Problem: Act Like an Owner
Mon, 08 Jul 2019
47 - Envy Can Be Useful, or It Can Eat You Alive
Fri, 28 Jun 2019
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