Econ 539-Public Policy Analysis: Market Failures 1 - Externalities

Now that we have reviewed: the basics of choice theory and how people respond in predictable ways (in aggregate) to incentives; the basics of the free market efficiency result; the basics of economic growth; the basics of strategic behavior and the sub-optimal market outcomes that can result; the basics of data analysis and the challenge of causality; and the basic economics behind budget analysis; we are now ready to study some classical market failures. [By the way, that is a lot of basics I just listed which is a good reminder of what I am trying to accomplish in this class: a good intuitive understanding of the logic of economics and how it applies to policy]

Today we will study the most talked about market failure: externalities.

These are most often discussed in environmental policy but can be both positive and negative and can arise anywhere. We will study how the presence of externalities - costs and benefits that do not accrue to the agent engaged the the particular economic activity - can lead to inefficient market outcomes and the policy perscriptions to deal with externalities. We will also take a closer look at pollution in particular and talk about the difference between Pigouvian taxes, strict caps and cap-and-trade.

For examples we will have a look at Portland's Business Improvement District, the US Department of Energy's Weatherization Assistance Program and the Ash Grove cement plant.

Credit Cards, Asymmetric Information and the Role of Government in Preventing Bad Choices

The new credit card (and guns) bill is about to be signed into law and it begs the question: what is the market failure that this government intervention is suppose to correct?  After all, credit card contracts are full information - all the facts are there for credit card applicants to review - and if a private citizen in the United States wants to enter in a legal contract with another entity, why should the government prevent this?

The answer lies in whether you believe that by making extraordinarily dense and complicated contracts an asymmetric information problem exists despite this 'full disclosure.'  Most consumers cannot make sense of the contracts, supporters of the bill say, and companies deliberately make contracts dense and confusing so that they can slip all kinds of nasty little provisions designed to take advantage of customers once they are in debt to the company.  

If this is true than a bill that regulated the type of contract language that can be used, how explicit the terms must be, how accessible the language is to an average person not trained in the law is justified.  But if this regulation was successful in making consumers informed about what type of contract they sign, does the government have any role in regulating the type of contract they sign?  As an example, what if the contract very clearly stated: interest rate may be changed at any time by the issuer without prior notice.  If I was quite happy to agree to this provision, why should the government prevent me from entering into a contract such as this.  The bill just about to become law does precisely this.

The answer from some circles is that you have to protect people from their own tendencies to make bad choices.  But is this really the role of government?  Some bad choices impose serious costs to society like not wearing a seat-belt - in a crash your are more likely to be seriously hurt and many people will rely on public assistance to pay their medical bills and even those insured will have to pay higher premiums on average. Do bad choices in the credit card market impose such social costs?  I doubt it.  I know we are in an economic crisis partly fueled by just such credit shenanigans, but again the lack of full information is a main culprit and I am supposing that this part of the problem is solved through regulation.

I like, therefore, the parts of the credit card bill that stipulate more transparency, but I dislike the restrictions on the type of contracts that will be allowed.

I think that we need to be careful that government does not start to try and explicitly guide behaviors that have no or little social cost.  I am fine with mandating that nutrition information be available to customers of restaurants upon request but if we required restaurants to include such information on menus as some have suggested, I think we cross the line in this regard.  The private costs of poor choices are enough to ensure efficient market outcomes.

Now, where is that double cheeseburger with king sized fries I ordered?...