Environmental Economics, Episode #22

In this week’s episode, Crash Course covers the topic of Environmental Economics.  Unfortunately, this episode mostly repeats the same economic lessons taught in the previous two episodes, making this week more of a bottle episode than anything else.  We’ve already covered Crash Course’s points on externalities and tragedy of the commons, but we will touch on some new concepts that Crash Course introduces.

Climate Change and Context

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For sake of simplicity[…], we’re going to focus on one type of pollution: carbon dioxide emissions. They’re one of the primary greenhouse gases.  These greenhouse gases basically blanket the earth and are causing climate change.  CO2 levels are the highest they’ve been for millions years which is why environmentalists consider it a “planetary emergency.”

There is without a doubt an enormous fervor about Climate Change (formerly known as “Global Warming”).  Scientists from across the spectrum agree on the principles about how carbon dioxide affects the atmosphere, but there is disagreement on the how bad the earth’s situation is and what is likely to happen in the future.  While your media source of choice might classify some beliefs as “denying” or “alarmist” about climate change, not many are talking about the real differences between the two scientific arguments.  These arguments are not on economics, but I thought I’d give my two cents since Crash Course seems pretty confident in their point of view that it is a “planetary emergency”.

Scientists agree that increasing carbon dioxide emissions means an increase in temperature.  This relationship is not doubted; however, what is argued is how much CO2 creates how much of an increase in temperature.  The jury is still out on this one.  So far, no one has been able to accurately predict the earth’s surface temperature year in and year out with predictive models, but people do have theories about how it is going to turn out.  We know now that the climate models of the 90’s were wrong (remember Al Gore’s hockey stick graph?), but as for the current models, we’ll have to wait to find out.

Scientifically speaking, Crash Course’s claim that it is a “planetary emergency” is at least debatable, depending on which predictive model you’re using.  But for the purposes of the rest of our analysis, we’re just going to assume that the goal is to reduce carbon emissions.

Rebound Effect

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Let’s say Hank uses a gallon of gas to drive to work everyday. Then, partially to help the planet but mostly to help his wallet, he buys a new fuel efficient car that only takes half a gallon of gas for the same commute. He saves money and there’s less pollution. It is a win-win.

The rebound effect says that the benefits of energy efficiency might be reduced as people change their behavior.  With the money he saves, Hank might start driving more than he normally would or he might go on a vacation in Hawaii. That leads to more consumption and possibly even more emissions.

The moral that Crash Course derives here is that it is very difficult to predict human behavior.  The entire financial sector trade trillions of dollars every day based on what they think humans will do, and many of them still get it wrong.  Governments, believe it or not, have even less at stake if they get these predictions wrong, and they are more likely to overlook the rebound effects (although it does look good to be doing something).

However, let’s not forget that energy efficient vehicles actually do wonders for the economy in other, non-environmental ways.  If Hank switches from a regular car to a hybrid, he is saving significant amounts of money which can later be spent on other consumer goods for himself.  Hank’s standard of living increases, and this is the real beauty of fuel efficient cars.

Government Investment

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Private companies and governments are also funding research into green technology.  In the U.S. the American Recovery and Reinvestment Act of 2009 allocated billions to fund renewable energy.

This is a great point that Crash Course brings up, although they fail to comment on the potential downside of government investment into green technology.  When free market economists think of the American Recovery and Reinvestment Act of 2009 in the field of green technologies, one company in particular comes to mind: Solyndra.

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Solyndra received over half of a billion dollars in loan guarantees from the federal government as a part of this 2009 law.  Two years later, the company filed for Chapter 11 bankruptcy and is being investigated by the FBI and the Treasury for accounting fraud.  As it turns out, Solyndra was not a good investment.  Remember my previous comment on governments not having much at stake when making these investment decisions?

I would have liked to see Crash Course comment on the potential economic downsides to government intervention.  Besides possibly wasting taxpayer money on poor investments, government intervention into a market will necessarily distort it, and sometimes the efficient and productive companies get pushed out if the government chooses unwisely.  To many economists, government intervention into any market (environmental or not) will do more harm than good for the consumers.

This week was a short one, but thanks for reading and be sure to come back every Thursday for a fresh post!  And don’t forget to join our newsletter and our facebook group, and comment below!

Market Failures, Taxes, and Subsidies – Episode #21, Part 2

We’re back for the second part of Crash Course Economic’s episode on Market Failures, Taxes, and Subsidies.  In this post we’ll cover the second half of the video, which talks about externalities, pollution, and the education system.  Let’s rock and roll:

Negative Externalities

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Remember, sometimes markets misallocate resources because they don’t have the right price signals. There is no better example of this than what economists call externalities. Externalities are situations when there’s an external costs or external benefits that accrue to other people or society as a whole.

Market misallocation of resources is something we covered last week in episode 20, so I won’t go into it here.  What Mr. Clifford is trying to say here is that markets don’t take into account negative externalities when pricing a product, since the companies don’t have to pay for these externalities.

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Let’s look at a TV factory that pollutes a river with toxic chemicals. This is definitely a negative externality […] There are also external costs associated with polluting the waterways, like dead fish, contaminated drinking water, and people getting sick […] The free market assumes that all the costs associated with producing TVs are accounted for within the price of those TVs, but, in this case, the market is wrong. The end result is a market failure because the factory is producing too many TVs.

This is a textbook example of a negative externality.  An entity is directly responsible for a lot of bad things, but the entity never has to take legal responsibility for it.  Something is clearly wrong here, but what’s the solution?  Crash Course offers one that’s used most often:

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Economists often look to the government to step in and solve the problem. For example, the government could tax the TV factory.

The taxes will increase the cost of producing each TV, and thus reduce the supply and raise the price of each one.  This bring the supply and price closer to what Mr. Clifford and many government economists have determined to be the appropriate supply/price for a TV, since according to them, the free market could not do it on its own.

While this solution may bring the supply and price closer to what the real market would be if the TV factory had to account for the negative externalities, it doesn’t clean the river, and it doesn’t incentivize the TV factory to stop polluting the river.  In the end, the river is still polluted, but now the government has more money.  Is this the trade off economists are looking for?

Instead, some economists suggest, the problem is one of property rights.  If someone owned the river or the right to use it, he could sue the factory for violating his property rights.  Since rivers are owned by governments (remember tragedy of the commons?), no private individual could sue the factory.  The government is satisfied with the taxation solution since it means a new stream of cash flow, but it probably doesn’t mean much to the people who have use the polluted river.  But where would the money collected from these taxes go (at least, in theory)?  To the positive externalities, of course.

Positive Externalities

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More education is great for you. You’ll likely generate more income and it makes you more interesting to talk to at parties. But there are also external benefits of your education. Everyone is actually made better off. With more education you’re more likely be a positive and productive member of society. And if you earn a higher income, that means more tax revenue.

Funding education would, in theory, produce graduates with much greater productive value.  This increase in value would be better off for the economy at large, since more wealth is now created.  That wealth would also be taxed.  If you’ve ever heard someone say that “subsidized education pays for itself,” this is the theory behind it.

Of course, this is assuming that putting money towards any school system is a good return on investment.  Considering the extremely high price of college tuition, is each dollar really spent wisely on improving the productive capacity of its students?

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If the government didn’t get involved, all education would be provided by private schools that would charge tuition; there might not be enough affordable schools to educate young people.  The government funds education because they think that the external benefits, like literate, well-informed, erudite citizens, are so high it’s worth forcing everyone to pay.

Well-informed, erudite citizens.  Is that the world we live in?  According to the most recent statistics, about a quarter of the United States is functionally illiterate.

Of course, it’s very difficult to speculate about what the market would look like if there were not any public education.  The education market as a whole is so heavily influenced by the public school system, economists can only theorize about what low-cost private schooling choices would appear if they were not crowded out by no-cost public schools.

But what economists always ask themselves is “compared to what?”  Would people be better off if the government put the money (wherever it comes from) toward education, some other project, or back in the hands of the citizens?  That’s very hard to tell, but for spending over $12,000+ on every elementary and secondary school student, would the students would be more literate, well-informed, and erudite if that money went to private tutoring?

Thanks for sticking around for part two of this week’s episode.  Please come back every Thursday for a fresh new post on a new episode.  And don’t forget to join our newsletter and our facebook group, and comment below!

Market Failures, Taxes, and Subsidies – Episode #21, Part 1

This week Crash Course takes a step in the pro-government direction, despite concluding at the end of this episode that neither markets nor government is “better,” but rather that the two must work together for everyone’s benefit.  This episode is such a doozy that it’ll be broken into two parts.  Let’s get started:

Prisoner’s Dilemma

The episode begins with a variation of the prisoner’s dilemma situation in game theory.  In short, the game offers someone a choice between something that will benefit them a lot vs. something that will benefit them a little, but if that person and other people (who are given the same choice) also choose the more beneficial option, then all parties end up with a very bad result.

 

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The [prisoner’s dilemma] question alludes to one of the biggest problems with free markets: sometimes people have a personal incentive to do something that is against the collective interests of the group.

I found this connection pretty attenuated, since this problem doesn’t really have anything to do with free markets.  In fact, this problem could be just as easily (or more easily) be connected to the tragedy of the commons than to the free market.  We’ll better explain these terms (market failures and the tragedy of the commons) later in this post.

Market Failures

Despite it being so important that it’s named in the title of the episode, the term Market Failures is only briefly defined before moving on.  Let’s look at how Crash Course introduces it:

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Things that are for our collective well being, like fire protection, schools, and national defense are often funded by the government. When markets alone fail to provide enough of these things, that’s called market failures.

The term “Market Failure” is used to describe when the market does not produce something (or enough of something) to meet consumer demand.  Markets are always adjusting to meet consumer demand, but the term Market Failure is usually used for allegedly huge discrepancies between supply and demand.

For example, Crash Course purports that if government fire departments did not exist, then there would not exist any fire protection for people.  Since people need fire protection, the government must step in during these Market Failures.

Confusingly, evidence of privately-owned and operated Fire Departments is so abundant, I’m surprised that Crash Course would use this as one of their examples where the market cannot provide.  National Defense is a much harder example to argue against, so I’m wondering why Crash Course extrapolated on their weakest example.  Of course the market can provide for fire protection services, since it does in many areas for less cost.

Public Goods

Crash Course gives the textbook definition of public goods:

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The technical definition of a public good is anything that has two characteristics: non-exclusion and non-rivalry. Non-exclusion is the idea that you can’t exclude people that don’t pay. For example, it’s impossible to limit the benefits of national defense to only people that pay their taxes. People who pay no federal taxes still get the benefit of protection from bombs, and people who pay a lot of federal taxes don’t get extra protection.  Non-rivalry is the idea that one person’s consumption of the good doesn’t ruin it for other people. So, public parks are a great example. You can use it today, I can use it tomorrow; it can be shared.

It’s hard to improve upon this definition.  One particular area to note, however, is that things like Fire Departments would not be considered public goods, since they are not non-rival.  One city cannot adequately provide fire protection services to 50 buildings that are on fire in different locations at the same time.

 While the definition of public goods is accurate, some schools of economic thought may have a problem with a common conclusion regarding public goods, which Crash Course gives immediately after defining it:

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If a good or service meets these two criteria it’s unlikely that private firms will produce it, no matter how essential it is.  Street lights and organizations that track and prevent the spread of diseases are pretty important, and if the government doesn’t step in, we probably won’t get them.

First, while Crash Course (and other economists) argue that it is unlikely the private firms will produce items that fit the definition of public good, there are plenty of examples to the contrary, especially today.  Any software or website made available for free or funded by donations (Wikipedia, WinRar, etc.) meet the definition of public good and were created privately.

Additionally, Crash Course’s two examples (street lights and the CDC) might not be the best examples to give.  Street lights would fall into the Tragedy of the Commons category (which we’ll get to, I promise), since they are on public property, and there exist plenty of private organizations that track and prevent the spread of diseases.

Tragedy of the Commons

Crash Course next talks about Tragedy of the Commons, one of the most important principles to any free market economist:

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The incentive to do what’s best for you, rather than what’s best for everyone is the root cause of something economists call the Tragedy of the Commons. This is the idea that common goods that everyone has access to are often misused and exploited.

The best visual understanding of The Tragedy of the Commons comes from William Forster Lloyd, whose example is still used to this day (via Wikipedia):

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In 1833 the English economist William Forster Lloyd published a pamphlet which included a hypothetical example of over-use of a common resource. This was the situation of cattle herders sharing a common parcel of land on which they are each entitled to let their cows graze, as was the custom in English villages. He postulated that if a herder put more than his allotted number of cattle on the common, overgrazing could result. For each additional animal, a herder could receive additional benefits, but the whole group shared damage to the commons. If all herders made this individually rational economic decision, the common could be depleted or even destroyed, to the detriment of all.[5] 

The Tragedy of the Commons is often used as an argument against public ownership of goods and for private property.  After all, if you are a farmer and owned your own parcel of land, it’s unlikely that you’ll let it become overgrazed, since that will hurt you in the future.  However, the writers at Crash Course see it a different way.  To them, Tragedy of the Commons is not a argument for privatization, but rather one for regulation.

The Tragedy of the Commons explains why fish stocks get depleted, the rainforest get cut down, and why endangered species get hunted for their hides or horns […]  The problem here is that unregulated markets sometimes don’t produce the outcome that society wants.

As Crash Course will talk about later in the video, there are two ways to look at the solutions to problems such as these: one is a regulatory solution, and the other is a market-based solution.

In general, economists tend to prefer market-based policies.

Despite admitting (and later explaining why) market-based policies are preferred, when talking about examples of Tragedy of the Commons problems, their proposed solution is nonetheless regulatory.  Crash Course never explains why they recommended the admittedly less preferable solution.

There’s still a lot to talk about with Crash Course’s analysis of externalities, the education system, and Cap & Trade, so be on the look out for a bonus blog post this Saturday.  And as always, you can expect a fresh post every Thursday.  Don’t forget to join our newsletter and our facebook group, and comment below!

Episode #20 – Price Controls, Subsidies, and the Risk of Good Intentions

Two weeks ago, when we last reviewed an episode, I was hoping that this week would be the third week in a row of solid and accurate economics from the good people at Crash Course.  Episode 18 talked about the rather non-controversial topic of principles of microeconomics, and episode 19 chopped down common arguments against what is commonly referred to as “price gouging” and “predatory pricing”.  Will they continue their streak in episode 20?

The answer is sort of, but not really.  In this episode, Crash Course starts strong by railing against government-imposed price ceilings and floors (including rent control), but gets a little weak when talking about the use of subsidies.  Let’s get started:

Price Controls

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Let’s say the government forced gas stations to charge a dollar per gallon for gas. This might seem like a good idea, right? Mandated lower gas prices mean we all benefit. Not really. Society is actually made worse off. When the gas prices fall consumers will want to buy more, but producers will no longer find it profitable to sell gas. The lower price will decrease the amount of gasoline produced, and we’ve got a shortage.

This relates to last week’s point on price gouging.  When the market price of a good is above what people are allowed to sell it for, sellers are not incentivized to increase their supply, and this results in a shortage.  If you’ve been following what’s happening in Venezuela, you’ll see that price controls results in long lines for essential goods (including toilet paper).

Crash Course makes a similar argument against price floors:

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Assume the government set a price floor for a bushel of corn at $7 when the actual equilibrium price is $4. The higher price would give farmers an incentive to produce more, but, at that high price, consumers would go buy substitutes […] The farmers wouldn’t necessarily be better off. They could sell corn at the higher price, but they wouldn’t have as many customers.

High prices naturally make fewer people buy a good. And fortunately, since consumers are not forced to buy any good (well, almost any good), they are more likely to take their money elsewhere, giving the sellers fewer customers and making them worse off overall.

Crash Course targets a specific type of price control popular in many urban areas, rent control:

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The lower rent discourages renovation and new construction, reducing the quantity supplied. The result is a shortage of apartments with landlords that have few incentives to maintain their buildings or be responsive to their tenant’s needs.

If you’ve ever tried to look for an apartment in a big city like New York or San Francisco, you’ll notice that prices are ridiculously expensive.  And for that expensive price, you receive a not-that-great apartment.  Those fortunate enough to live an a rent controlled building become very discouraged from leaving, since they would have to pay the market rate if they moved apartments.   Meanwhile, everyone not in a rent control building is subjected to high prices, low supply, and poor living conditions.

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