EXTERNAL COSTSWHEN OUR DECISIONS AFFECT OTHER PEOPLE

COSTS Cost-Benefit Analysis means you weigh the costs and

benefits of all of your alternatives (trade-offs) Costs can be monetary ($) or they can involve time or

risk There is also opportunity cost. When you decide to

do one thing, you are giving up the opportunity to do another thing (your second choice)

EXTERNAL COST (EXTERNALITY) External costs are costs of your decision, which you

don’t have to pay, but may affect someone else (or society)

It places a cost on someone else. (NEGATIVE EXTERNALITY)

There can also be external benefits. Your decision affects other people positively. (POSITIVE EXTERNALITY)

EXTERNAL COST EXAMPLES For each of the examples…

1. Identify the economic player (who’s making the decision)

2. Identify the external cost (or benefit) 3. Identify who pays the cost (or reaps the benefit)

EXAMPLES 1. A manufacturing plant causes air pollution.

2. An on-campus fraternity decides to have a late-night party on a Saturday night in a neighborhood where there are also elderly people and parents with young children.

EXAMPLES 3. The unregulated use of antibiotics by doctors has

led to the emergence of powerful antibiotic-resistant bacteria.

4. A beekeeper keeps bees in order to collect honey to sell for profit. The bees also pollinate fruit trees in the area.

EXAMPLES 5. Coal-powered energy plants emit greenhouse

gases, which have been associated with climate change.

6. An individual chooses to fire-proof his home, which means that his neighbors’ risk of fire is also reduced.

EXAMPLES 7. I decide to drive my car to work, which adds to

congestion on the roads and higher accident risks for other drivers.

8. A parent vaccinates his child to keep the child from contracting a disease. The vaccinated child decreases the likelihood that others in the community will contract the disease.

EXAMPLES 9. A company dumps toxic waste from its

manufacturing plant into a local stream.

10. A movie-goer uses his cell phone during the movie, to the annoyance of other movie-goers.

SCENARIO 1 The Broomfield City government keeps track of traffic

patterns in the city and county of Broomfield. They have noticed traffic problems on 144th during rush hour. Currently, 144th is a two lane road with one lang going in each direction. The government is trying to decide whether or not to widen the road.

Are there any external costs of this decision?

SCENARIO 2 A business that makes tires is trying to decide

whether to open a factory in an industrial area near your house. The production of rubber for the tires produces smoke and water pollution.

Are there any external costs of this decision?

WHO REFEREES? In the case of external costs,

there is no incentive for the economic player who is causing the problem to change their behavior. Why?

In the case of external costs that affect the entire society, who has to play referee?