A role for government (2): Dealing with externalities

This previous post tells the story of how government can deal with externalities (which, by the way, is a very important concept for you to know, so click the link!) through regulations. Now, economists usually prefer a different means to deal with externalities, i.e., taxation. Specifically, it is usually called a “Pigovian tax“.

In fact, Greg Mankiw, economics professor at Harvard, went so far as to “start” the Pigou Club. An excerpt from his “manifesto” published in the Wall Street Journal:

With the midterm election around the corner, here’s a wacky idea you won’t often hear from our elected leaders: We should raise the tax on gasoline. Not quickly, but substantially. I would like to see Congress increase the gas tax by $1 per gallon, phased in gradually by 10 cents per year over the next decade. Campaign consultants aren’t fond of this kind of proposal, but policy wonks keep pushing for it. Here’s why…

You can read the rest here. Once you know what externalities are, you’ll see how this (standard economics) idea makes good sense.

Microeconomics implies people are stupid?

…or so he says based on Greg Mankiw’s 10 Principles of Economics. Enjoy!

I, Pencil

A must-read. A classic, most beautiful story by Leonard Read about how the market works, that begins:

I am a lead pencil—the ordinary wooden pencil familiar to all boys and girls and adults who can read and write.

Writing is both my vocation and my avocation; that’s all I do.

You may wonder why I should write a genealogy. Well, to begin with, my story is interesting. And, next, I am a mystery—more so than a tree or a sunset or even a flash of lightning. But, sadly, I am taken for granted by those who use me, as if I were a mere incident and without background…

…I have a profound lesson to teach. And I can teach this lesson better than can an automobile or an airplane or a mechanical dishwasher because—well, because I am seemingly so simple.

Simple? Yet, not a single person on the face of this earth knows how to make me. This sounds fantastic, doesn’t it? Especially when it is realized that there are about one and one-half billion of my kind produced in the U.S.A. each year.

You can read the rest here. One will be hard-pressed to find a better, more beautifully-written illustration of Adam Smith’s “invisible hand” than this little story.

In the news: Price floors in France

Rent control, described in this post, is an example of price ceiling. Now this story in LA Times describes one version of price floors on department store goods in Europe:

In America, merchants hold sales whenever they like. In parts of Europe, it’s the government that makes the rules.Twice a year, in January and June or July, French law allows retailers to post the word “sale” in their windows and significantly cut prices.

The costs of such a price floor?

The government sets the dates, and for four to six weeks, there is mayhem. The usual French decorum is dropped as shoppers, who on an ordinary day wouldn’t dream of eating lunch or drinking a cup of coffee on the streets the way Americans do, gobble baguette sandwiches as they race from shop to shop.

and at an aggregate level:

[Such] restrictions help explain why in France and in the euro zone, consumer spending is expected to account for about 56% of the gross national product in 2007, compared to 70.3% in the U.S., according to the Organization for Economic Cooperation and Development.

Another example for price floors (again from France) is this ban on free shipping for Amazon.com. Typically, price floors make consumers bear the cost at the behalf of protected producers, which is why it’s great to see that Amazon is fighting back.

A role of government (1): Providing public goods

An interesting thing about Chapter 4, which I plan to cover next week, is on the role of government. So far, I have argued that in general, the market system is a good thing because it is efficient. However, there are circumstances in which markets do not work very well in allocating resources. We call such circumstances market failures.

Charles Wheelan, author of this excellent popular economics book, has this article written post Hurricane Katrina, which anticipates one of the two possible resource reallocation roles of government, namely public goods provision, that we’ll be discussing next week:

What Government Should Do

Markets work best when government provides public goods. These are not, as the name wrongly suggests, anything purchased with public money. Instead, public goods have two salient characteristics: 1) They can be provided just as cheaply for thousands or even millions of people as they can for a single individual and 2) It’s difficult or impossible to prevent people who haven’t paid for such goods from enjoying their benefits.

For example, the levees protecting New Orleans…

You can read the rest of the article here. Notice that in the textbook, the first characteristic of public goods described above is known as “non-rival”; the second one, “non-excludable”.

Another resource reallocation role for the government is in dealing with externalities. See this post for an example.

In the news: Local business, “municipal” cost

In today’s LA Times, an example of negative externalities which is an important subject of Chapter 4. On the one hand, the private benefits of rush-hour parking:

Customers hoping to savor challah at their Shabbat dinners know that the line often trails out the door of Delice Bakery on West Pico Boulevard.

The purveyor of French kosher breads and pastries sells hundreds of its creations every Friday.

That’s why owner Julien Bohbot said he “went berserk” when he read about Mayor Antonio Villaraigosa’s plan to eliminate rush-hour parking on Pico and Olympic boulevards as part of a three-phase program to reduce travel times on the busy roads, especially at congested points on the Westside.

But on the other hand, there is a social cost:

[Councilman] Weiss acknowledged that some people were upset about the proposed changes. “It would be unrealistic if I didn’t acknowledge that there will inevitably be some impact” on businesses, he said. “But hundreds of thousands of people travel through this area on a daily basis, and they’re asking for relief and we’re trying to give it to them,” he said.

You can read the rest of the article here. Of course, it is not as if the hundreds of thousands of travelers are innocent — cars and drivers create negative externalities by polluting the environment at the expense of non-drivers. There is, as usual, a trade-off to consider. This one argues that off-the-street parking has greater social costs.

Why markets work (2)

A beautiful, classic elaboration by F. Hayek of why the market system works more efficiently than command economies:

The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate “given” resources—if “given” is taken to mean given to a single mind which deliberately solves the problem set by these “data.” It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.

See the rest here for the pdf version (available via JStor, which is accessible from USC connections) or here for the html version. It’s a 12-page article, very readable, and highly recommended.

Why markets work (1)

John Kay contrasts between abilities of command vs. market economy to accommodate change:

In an uncertain, changing world, most decisions are wrong, and success comes not from the inspired visions of exceptional leaders, or prescience achieved through sophisticated analysis, but through small-scale experimentation that rapidly imitates success and acknowledges failure. This disciplined pluralism is the true genius of the market economy.

You can read the rest of the article here.

The opportunity cost of motherhood

Steven Landsburg reviews a study on the price of motherhood:

On average, Miller has found in a new paper, a woman in her 20s will increase her lifetime earnings by 10 percent if she delays the birth of her first child by a year. Part of that is because she’ll earn higher wages—about 3 percent higher—for the rest of her life; the rest is because she’ll work longer hours. For college-educated women, the effects are even bigger. For professional women, the effects are bigger yet—for these women, the wage hike is not 3 percent, but 4.7 percent.

Read the rest of the article here. Also, here are his other articles at Slate.

In the news: Price controls

In LA Times today:

Los Angeles has rent control on all apartments built before Oct. 1, 1978, and on mobile home parks whose operating permits were issued before Feb. 10, 1986.
…

Generally, the laws allow landlords to raise rents by a limited amount — in many jurisdictions by the amount of the consumer price index. Whenever a unit is vacated, the landlord can reset the rent at market level. But while the unit is occupied, rent increasesare subject to controls.

“That sets a perverse incentive for landlords to charge the highest rent when an apartment is vacated,” said Jon Coupal, president of the Howard Jarvis Taxpayers Assn.

Coupal said the long-term effect of rent control laws is to reduce the amount of affordable housing because developers won’t invest in it.

Also, generally, on price control, here is Thomas Sowell:

Why do price controls cause shortages? There are basically two reasons: supply and demand.

We will talk about supply, demand, and price controls in the next two weeks.

PS: For enthusiasts only, this and this are two NBER papers on rent control.