An Introduction to Externalities
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0:00 - 0:03♪ [music] ♪
-
0:09 - 0:11- [Prof. Alex Tabarrok]
In previous videos, -
0:11 - 0:14we've emphasized
that a price is a signal -
0:14 - 0:16wrapped up in an incentive,
-
0:16 - 0:18and that prices
coming out of free markets -
0:18 - 0:20coordinate individual actions
-
0:20 - 0:23in just such a way
that the outcome -
0:23 - 0:27looks as if it were created
by a benevolent invisible hand. -
0:28 - 0:31We've shown how price controls
can impede this process. -
0:31 - 0:33And what we want to show now
-
0:33 - 0:35is that even with the free market,
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0:35 - 0:38sometimes the price isn't right.
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0:38 - 0:41In particular,
when we have externalities -- -
0:41 - 0:43external costs,
and external benefits, -
0:43 - 0:45which I'll define more
in just a few minutes -- -
0:45 - 0:48then the price isn't right.
-
0:48 - 0:50So what we want to do in this video
-
0:50 - 0:53is show both the causes
and the consequences -
0:53 - 0:56of external costs
and external benefits. -
0:56 - 0:57Let's get going.
-
1:01 - 1:04Let's begin with the rise
of the super bugs. -
1:04 - 1:08These are bacteria which are now
resistant to our antibiotics. -
1:08 - 1:11Before the age of the antibiotic,
-
1:11 - 1:15even a simple skin cut
or a bruise or scrape -
1:15 - 1:17could kill people
due to the infection. -
1:17 - 1:19And people
who were more seriously injured, -
1:19 - 1:21for example in battle,
-
1:21 - 1:23most of them died
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1:23 - 1:24not because of their battle wounds,
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1:24 - 1:28but because of infection
which took place after the wound, -
1:28 - 1:30because of the wound.
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1:30 - 1:32In the 20th century,
-
1:32 - 1:36the miracle of antibiotics
meant that far, far fewer people -
1:36 - 1:38died from these infections.
-
1:38 - 1:41But that miracle
is now coming to an end, -
1:41 - 1:43as our antibiotics
-
1:43 - 1:46are no longer as effective
as they once were. -
1:46 - 1:48Why is this happening?
-
1:48 - 1:50Well, part of the problem
-
1:50 - 1:54is that no antibiotic
is always 100% effective. -
1:54 - 1:57And bacteria,
like people, are diverse. -
1:57 - 2:00They have different strengths
and different weaknesses. -
2:01 - 2:04The bacteria which are
not killed by an antibiotic -- -
2:04 - 2:06which happen to have
certain characteristics -
2:06 - 2:10which make them strong
against that antibiotic -- -
2:10 - 2:12those bacteria
propagate and survive -
2:12 - 2:14and become more dominant.
-
2:14 - 2:19So, the evolutionary process
has led to resistance. -
2:20 - 2:23We, however, are not
entirely innocent in this process. -
2:23 - 2:29Resistance has been helped
by the overuse of antibiotics. -
2:29 - 2:32So why are antibiotics overused?
-
2:32 - 2:34The fundamental reason
-
2:34 - 2:36is that users get all the benefits
-
2:36 - 2:40but do not bear all of the costs
of antibiotic use. -
2:40 - 2:42Each use of an antibiotic
-
2:42 - 2:45creates a small increase
in bacterial resistance, -
2:45 - 2:47at least in a probabilistic sense.
-
2:47 - 2:51But bacteria don't stay
in one place or one body. -
2:51 - 2:53They spread
throughout the environment -
2:53 - 2:54and indeed throughout that world.
-
2:54 - 2:59So an increase, that cost,
that increase in bacterial resistance -
2:59 - 3:01is a cost borne by everyone,
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3:01 - 3:04not just the user
of the antibiotic. -
3:05 - 3:07We can think of using an antibiotic
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3:07 - 3:09as creating a little bit of pollution,
-
3:09 - 3:11of polluting the environment
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3:11 - 3:14with more resistant
and stronger bacteria. -
3:14 - 3:17This is true when somebody,
for example, -
3:17 - 3:19uses an antibiotic
when they have a virus -
3:19 - 3:21which the antibiotic
doesn't help with, -
3:21 - 3:24rather than
when they have bacteria. -
3:24 - 3:25That's a cost.
-
3:25 - 3:28It's a cost because
that use of the antibiotic -
3:28 - 3:30then generates more resistance,
-
3:30 - 3:33and that resistance
spreads around the world. -
3:33 - 3:36Farmers who use antibiotics,
-
3:36 - 3:38not to combat disease
in their livestock, -
3:38 - 3:41but to help
the livestock grow faster, -
3:41 - 3:45also create more
bacterial resistance. -
3:45 - 3:49But that resistance
is something they don't include -
3:49 - 3:51in their calculus of costs.
-
3:51 - 3:52They don't pay attention
-
3:52 - 3:55to those costs
which are borne by other people. -
3:56 - 3:57When antibiotic users
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3:57 - 4:02ignore the external costs
of their choices, -
4:02 - 4:04we get overuse.
-
4:04 - 4:07Since some costs are ignored
by the decision makers, -
4:07 - 4:10we get overuse of antibiotics.
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4:10 - 4:12Okay, well,
with that as an introduction, -
4:12 - 4:14let's define some terms.
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4:14 - 4:15Private cost --
-
4:15 - 4:19this is the cost paid
by the consumer or the producer. -
4:19 - 4:21External cost --
-
4:21 - 4:24this is a cost paid by bystanders,
-
4:24 - 4:27by people other than
the consumer or the producer. -
4:27 - 4:30It's a cost paid by people
other than those -
4:30 - 4:32who are buying or selling
-
4:32 - 4:34in this particular market.
-
4:34 - 4:37The social cost
is the cost to everyone -- -
4:37 - 4:39the cost when we take into account
-
4:39 - 4:42consumers, producers
and bystanders. -
4:42 - 4:44In other words,
-
4:44 - 4:47it's the private cost
plus the external cost. -
4:48 - 4:49Externalities --
-
4:49 - 4:52this is simply another word
for external costs -
4:52 - 4:54or external benefits.
-
4:54 - 4:57We'll talk more about
external benefits in a future talk. -
4:57 - 5:00In other words, externalities
is just another word -
5:00 - 5:04for costs or benefits
that fall on bystanders. -
5:05 - 5:07When there are
significant external costs -
5:07 - 5:09or external benefits,
-
5:09 - 5:12a market will not
maximize social surplus. -
5:12 - 5:14Now, remember we showed earlier
-
5:14 - 5:17that a market maximizes
consumer surplus -
5:17 - 5:19plus producer surplus.
-
5:19 - 5:22That's always true
for a free market. -
5:22 - 5:23However, what we've just learned
-
5:23 - 5:28is that an external cost
is a cost that falls on bystanders, -
5:28 - 5:30not on consumers or producers.
-
5:30 - 5:34So social surplus,
which is consumer surplus -
5:34 - 5:37plus producer surplus
plus bystander surplus -- -
5:37 - 5:40that's ultimately
really what we care about. -
5:40 - 5:42We care about not just
about consumers and producers, -
5:42 - 5:46we care about everyone
including bystanders. -
5:46 - 5:49So we want
to maximize social surplus. -
5:49 - 5:50However,
-
5:50 - 5:53when there are significant
external costs or benefits, -
5:53 - 5:56the market is not going to
maximize social surplus. -
5:56 - 5:58It's going to maximize
consumer surplus -
5:58 - 6:00plus producer surplus.
-
6:00 - 6:02But that's not everything.
-
6:02 - 6:05When the costs
and the benefits to bystanders -
6:05 - 6:07are not counted,
-
6:07 - 6:10then we're not going to
maximize social surplus. -
6:10 - 6:13In fact, we can say things
a little bit more precisely, -
6:13 - 6:17and we'll do that next
with a supply and demand diagram. -
6:17 - 6:19Okay, here's our standard diagram
-
6:19 - 6:21with the quantity of antibiotics
on the horizontal axis -
6:21 - 6:24and prices and costs
on the vertical axis. -
6:24 - 6:26As usual, the equilibrium is found
-
6:26 - 6:28where demand intersects supply,
-
6:28 - 6:31or where quantity demanded
is equal to quantity supplied. -
6:31 - 6:33Now the key point here
-
6:33 - 6:37is that the supply curve
is based on private cost -- -
6:37 - 6:40basically the cost
of producing the antibiotic. -
6:40 - 6:42But there's another cost.
-
6:42 - 6:46Every time an antibiotic
is produced and consumed -
6:46 - 6:49there's a cost
of bacterial resistance, -
6:49 - 6:53a cost borne by all of us,
by bystanders. -
6:53 - 6:55There's an external cost
-
6:55 - 6:59and that is not taken
into account by the suppliers. -
6:59 - 7:03So this external cost
doesn't go into the price. -
7:03 - 7:06Nevertheless,
what we really care about -
7:06 - 7:09is the social cost
of antibiotic use, -
7:09 - 7:12not just the cost
of producing the antibiotic, -
7:12 - 7:14but also the cost
of actually using it, -
7:14 - 7:16including the external cost.
-
7:16 - 7:20So, the market equilibrium,
the market quantity, -
7:20 - 7:23is found where the market
demand and supply curves intersect. -
7:23 - 7:26But the true efficient equilibrium,
-
7:26 - 7:29the equilibrium
we would like to be at, -
7:29 - 7:34is where the demand curve
intersects the social cost curve. -
7:34 - 7:36So, the efficient quantity
-
7:36 - 7:41is less than the market quantity,
thus we have overuse. -
7:41 - 7:44The market doesn't
take into account -
7:44 - 7:48all of the costs of antibiotic use
-
7:48 - 7:50so we get overuse
-
7:50 - 7:52relative to
the efficient equilibrium. -
7:53 - 7:55Now we can actually show this
in another way. -
7:55 - 8:00Let's look at the value
of the marginal unit, -
8:00 - 8:02the value of the unit,
the market unit, -
8:02 - 8:05the last unit the market produces.
-
8:05 - 8:08What's the private value,
what's the value of this unit? -
8:08 - 8:11Well, it's given by the height
of the demand curve. -
8:11 - 8:14Now, what is the cost
of that marginal unit, -
8:14 - 8:17of that last unit consumed?
-
8:17 - 8:20Well, the private cost is given
by the private supply curve, -
8:20 - 8:27but the social cost is given
by the much higher social cost curve. -
8:27 - 8:29So notice on that last unit,
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8:29 - 8:35the cost of that last unit
is much larger than the value. -
8:35 - 8:38That's the sense
in which we have overuse. -
8:38 - 8:40We don't really want
to produce this last unit -
8:40 - 8:44because the cost
is greater than the value. -
8:44 - 8:47Indeed, if we don't
want to produce this unit, -
8:47 - 8:49we don't to produce any unit
-
8:49 - 8:53where the social cost
is greater than the value. -
8:53 - 8:54So in other words,
-
8:54 - 8:58this area right here
is a deadweight loss. -
8:58 - 8:59These are the units
-
8:59 - 9:04for which the social cost
is greater than the private value. -
9:04 - 9:06Therefore, these are the units
we don't want to produce -- -
9:06 - 9:08this is the deadweight loss
-
9:08 - 9:12and this is the overuse
of the antibiotic. -
9:14 - 9:16What conclusions can we make?
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9:16 - 9:18When there are external costs,
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9:18 - 9:21output should be reduced
to maximize social surplus. -
9:22 - 9:24Another way of thinking about this
-
9:24 - 9:26is for determining
the efficient level of output, -
9:26 - 9:28who bears the cost is irrelevant.
-
9:28 - 9:32The fact that these costs
are borne by bystanders -
9:32 - 9:33is irrelevant --
-
9:33 - 9:35we want to take
into account all costs, -
9:35 - 9:38not just the cost to the suppliers.
-
9:38 - 9:41The problem is,
is that when other people -
9:41 - 9:43bear some
of the cost of production, -
9:43 - 9:45the price is too low.
-
9:45 - 9:49Not all of the costs
are reflected in the price. -
9:50 - 9:53As a result, the price
is sending the wrong signal. -
9:53 - 9:56It's incentivizing
too much production. -
9:56 - 9:58Because the price is too low,
-
9:58 - 10:01antibiotic users
purchase too many antibiotics -
10:01 - 10:03and we get overuse.
-
10:04 - 10:07The solution to this,
or one solution to this, -
10:07 - 10:10is in what's called a Pigouvian tax --
-
10:10 - 10:12a tax on a good
with external costs. -
10:12 - 10:14Let's take a look
at how that works. -
10:15 - 10:17The idea of a Pigouvian tax,
-
10:17 - 10:20after the economist Arthur Pigou
first talked about these ideas, -
10:20 - 10:22is pretty simple.
-
10:22 - 10:24The market equilibrium
is down here. -
10:24 - 10:27The efficient equilibrium is here.
-
10:27 - 10:30The problem is that the suppliers
-
10:30 - 10:34aren't taking into account
all the costs of their production. -
10:34 - 10:37They're not taking into account
these external costs. -
10:37 - 10:39So how could we get
these suppliers -
10:39 - 10:43to take into account all
of the costs of their production? -
10:43 - 10:47Well, one way
of doing it is to tax them. -
10:47 - 10:51A Pigouvian tax
equal to the external cost -
10:51 - 10:54makes the private cost
plus the tax, -
10:54 - 10:57the total private cost,
equal to the social cost. -
10:58 - 11:01Let's remember
how we can analyze a tax. -
11:01 - 11:03Remember that one of the ways
to analyze a tax -
11:03 - 11:07is to shift the supply curve up
by the amount of the tax. -
11:07 - 11:10So, if we impose
a tax on the suppliers -
11:10 - 11:13equal to the external cost
-
11:13 - 11:15the supply curve will shift up
-
11:15 - 11:19until the private cost plus the tax
-
11:19 - 11:21is equal to the social cost.
-
11:21 - 11:23In this case,
-
11:23 - 11:25we will now have
the efficient equilibrium -
11:25 - 11:28will be the same
as the market equilibrium. -
11:28 - 11:32The market
will internalize the externality. -
11:32 - 11:33All of the costs,
-
11:33 - 11:37private cost plus the tax
equal to the external cost, -
11:37 - 11:40will come to be
reflected in the price. -
11:40 - 11:43And because all of the costs
are reflected in the price, -
11:43 - 11:47consumers will buy
the efficient quantity of the good. -
11:47 - 11:52So, that's one way to handle
an external cost problem. -
11:52 - 11:54In the next couple of lectures
-
11:54 - 11:56we'll be talking
about external benefits, -
11:56 - 11:58and we'll also illustrate
some other ways -
11:58 - 12:01in which externalities
can be handled. -
12:02 - 12:03- [Narrator]
If you want to test yourself -
12:03 - 12:05click “Practice Questions.”
-
12:06 - 12:09Or, if you're ready to move on
just click “Next Video.” -
12:10 - 12:12♪ [music] ♪
- Title:
- An Introduction to Externalities
- Description:
-
What are externalities and what are the different kinds of costs? And what does this have to do with the rise of “superbugs"? This video is an introduction to externalities, including the concepts of private cost, external cost, and social cost. Using the example of antibiotics and viruses, we take a look at how costs are passed along to different members of society beyond the producer and consumer. We’ll use a chart to illustrate how to calculate the effects of a Pigouvian tax, and we provide definitions for the other key terms that will be used throughout this video series.
Microeconomics Course: http://mruniversity.com/courses/principles-economics-microeconomics
Ask a question about the video: http://mruniversity.com/courses/principles-economics-microeconomics/externalities-definition-pigovian-tax#QandA
Next video: http://mruniversity.com/courses/principles-economics-microeconomics/flu-shot-positive-externalities-pigovian-subsidy
- Video Language:
- English
- Team:
- Marginal Revolution University
- Project:
- Micro
- Duration:
- 12:15
Marilia_PM edited English subtitles for An Introduction to Externalities | ||
Cindy Hurlow edited English subtitles for An Introduction to Externalities | ||
Cindy Hurlow edited English subtitles for An Introduction to Externalities | ||
Cindy Hurlow edited English subtitles for An Introduction to Externalities | ||
MRU2 edited English subtitles for An Introduction to Externalities | ||
MRU2 edited English subtitles for An Introduction to Externalities | ||
MRU2 edited English subtitles for An Introduction to Externalities | ||
MRU2 edited English subtitles for An Introduction to Externalities |