Part 3 (2/2)

Youyourself why you've read a chapter, even a brief one, about some bizarre economists' fantasy The answer is that the fantasy helps us understand why econoht direction We know that a world of perfect ood as we're going to get When real world economies malfunction, we know to look for the market failures-and to do our best to patch them up

We've already explored one of those failures: some companies have scarcity power and can set prices that are far above their true cost, which is where they would be in a competitive market This is why econo in favor ofin favor of business, especially particular businesses A politician who is in favor of markets believes in the importance of co too much scarcity power A poli-tician who's too influenced by corporate lobbyists will do exactly the reverse

Whether abetted by politicians or otherwise, companies with scarcity power are one market failure There are two others In the next two chapters, we'll encounter the up to the real world once again

FOUR

Crosstown Traffic

We've just learned that in the world of perfectis for the best We know that perfectoutcomes that are flawless in every respect except distribution We also know from the head start theorem that we can fix any complaints about distribution in advance Presto, every proble the allocation of goods and services

That's nice to hear, but then why did I spend two hours stuck in traffic on the way to work this ? The bumper-to-bumper traffic was a stupid waste All of us could have been riding buses, or carpooling, and ould have reached our destina-tions in don DC in fifteen minutes Where is the perfect market there? The obvious answer is that, of course, there is noaround on the streets What may be less obvious is that there could be

Economies that work smoothly because they are full of perfectnor realistic But because perfect markets provide such a clear benchmark, economists find itwrong, rather than start froht And thisabout the world will lead us to the cure for crosstown traffic

What's wrong with s in my life that infuriate me and that I wish could be different I wish I didn't have to upgrade reat expense I wish that I could rely on ive me appropriate -ton's streets were not clogged with traffic and filled with pollution

These three personal, if corumbles correspond to the three key ways in which markets fail to live up to chapter 3's lofty ideals of perfection Markets fail to ell in the face of scar-city power, asin chapter 2 That is one of the proble cole coh prices Markets also fail to ell if soo to ood treatment, while he has no need to take into account the cost of the treatment, and my insurance co the true situation (We'll deal with health care in chapter 5) Finally, mar-kets fail to ell if some people asoline froas station, that is all very well for the driver and the gas station but not for the bystanders, including other drivers, who have to breathe the re-sulting carbonproblems are called ”market failures”: scarcity pohich we discussed in chapters 1 and 2;informa-tion, which ill discuss in chapter 5; and the subject of this chapter, decisions that have side effects on bystanders Econo-mists call the side effect an ”externality” because it lies outside the original decision, for instance, the decision to buy gasoline Whether because of scarcity power, incomplete information, or an externality, when the economy fails to live up to the idealized ”world of truth,” trouble is in store

How drivers affect bystanders Washi+ngton DC, London, Tokyo, Atlanta, Los Angeles, and Bangkok, and indeed any of the world's great cities, are full of cars, buses, and trucks Those vehicles seriously dae the hap-piness of innocent bystanders They cause severe air pollution Admittedly, London's current air pollution is not as severe as the ”Great Stink” of the 1850s, in which tens of thousands died of cholera But still, air pollution from traffic is not trivial: many thousands of people die because other people want to drive Around seven thousand people a year die prematurely because of traffic pollution in Britain, a little more than one in ten thou-sandIn the United States, the Environency estimates that fifteen thousand people die prematurely because of the particulate ines Within urban areas like London, the cost of delays froestion are even worse, if you consider the nu in any way a significant loss of pro-ductive or enjoyable life Then there is the noise, the accidents and the ”barrier effect,” which discourages people, and particularly children, fro to school, the local stores, or even to hbors across the street

People are not fools: it's al a trip in a car is benefiting fro so at the expense of everyone else around them-the other driv-ers stuck in traffic, the parents who dare not let their children walk to school, the pedestrians who risk their lives dashi+ng across the street because they are tired of waiting for the light to change, the office workers who even in the sweltering summer cannot open their s because of the roar of the traffic

Because each driver who gets into his car is creating misery for other people, the free market cannot deliver a solution to the probleestion and pollu-tion are important departures from the ”world of truth” In the ”world of truth” every act of selfish behavior is turned to the coood I selfishly buy underwear because I want it, but in doing so channel resources into the hands of underwear manufacturers, and do nobody any harm Textile workers in China, where the underwear is made, selfishly look for the best job, while manufacturers selfishly look for the most capable eoods are manufactured only if people want them, and they are manufactured only by the most appropriate people to do the job Self-centered motives are put to work for everybody

Drivers are in a different situation They do not offer compensation for the cost they inflict on other people When I buy underwear, the money I spend is co it and selling it to me When I take the car for a drive then I do not even need to think about the costs incurred by the rest of society as I avail myself of the free roads

Different kinds of prices: Marginal and average It is not quite fair to say that drivers can use the roads for nothing In the United Kingdoal to drive a car, or even to park it on public streets, unless you have paid a sizable annual tax called ”Vehicle Excise Duty” Many states in the United States have a sih to cause great resentment In the autuh fuel prices prevented fuel reaching the country's gas stations, and brought Britain to a standstill In Britain, drivers pay 20 billion in taxes on cars and fuel every year; in Aure is around 100 billion To ask ”have they paid enough?” is to ask the wrong question The right question is, ”are they paying for the right things?” The answer is no

There are two different concepts of price at play here, and the distinction e price that a driver pays for a journey across a city is quite high if the driver is paying an annual license fee But the price that the driver pays for one extra trip across the city is low: the trip doesn't burn ed for extra trips Once you've paid for the right to take the car on the street in the first place, you don't get a dis-count for low ht as well drive and drive, because it won't put a penny on your tax bill That is the difference be-tween the average price and the inal price, which is the price for one extra trip

To understand why the difference e, clubs and societies used to have big par-ties where soly, most people drank far too much This was because there were two types of ticket ”Alcoholic” tickets allowed unli after payment of an up-front fee of, say, ten pounds (at that time, about fifteen dollars) The other type of ticket was a lot cheaper, and you had to drink rancid orange juice instead and stand in a corner while the drinkers gota couple of beers was a pretty ex-pensive proposition, so most people preferred either toopportunity, or opt out of drinking alcohol coh soood parties

Since the university felt that the drunkenness represented a proble with it at the next party by raising the up-front fee to, say, twenty pounds (about thirty dol-lars) But the likelihood would be that while a few people would switch to being disgruntled orange-juice drinkers or give up on the society altogether, most of the drinkers would decide there wasn't , they would e, many of them would empty the contents of their stomachs

The university misunderstood the proble too ht that the solution probably involved raising the price of drinking The proble the price of drinking There's the price of being a drinker: ten pounds There's the average price of a drink: for the typical student who has twenty drinks, this is fifty pence Then there's the inal price of a drink, which is zero Once you've paid the up-front fee, you

Question: if you were running the university, would you deal with the proble better orange juice?, or (c) scrapping the up-front fee and charging people for what they drank?

Better orange juice est that the solution to the underlying probleestion If you were advising the secretary of transportation you y with student parties Currently, potential drivers have two options: they can cough up a large up-front fee and drive as much as they like; or they can not drive at all This second option, the ”orange-juice” option, requires theh as with the student party, the more people who choose the first option, the less attractive the second option becoht even propose so; (b) supply better ”orange juice” (s); or (c) scrap the up-front fee and charge people for the trips they drive

All of these options could be expected to reduce traffic congestion to some extent, perhaps to an important extent But it is option (c) that attempts to deal with the cause of the problem Drivers do not live in the ”world of truth”; that is they do not pay the true cost of their actions, including the ”externalities” or side effects that affect bystanders Option (c) tries to ht call it an ”externality charge”

Currently, every potential driver is being offered the sa students: put up a wad of cash in exchange for an unli in return There are no half measures

Student parties were not livened up excessively by the fact that drinks worked out at fifty pence (less than one dollar) on average: they were livened up excessively by the fact that the next drink was always free Siestion is not caused by the fact that the tax on a car trip is fifty cents on average: it is caused by the fact that the next trip is always free

We et obsessed with the question of how e Certainly, how e is an important question of distribution While distribution is i ied up and our cities are polluted

What estion is the price drivers pay at the in; or, to put it another way, the price drivers pay to estion, after all: car trips are the proble by charging students per drink Sie appropriate levels of driving byshould reflect the da, as usual In most European countries, drivers do pay a tax per h tax on fuel But the tax on fuel doesn't closely match the costs that drivers inflict on each other and on nondrivers People in rural areas pay the taxes (typically they spend between a quarter and a third as asoline as those in urban areas), but it is the commut-ers in the London, New York, or Paris rush hours who are caus-ing the estion, severe air pollution, and noise The sa do not cause congestion, although pollution and noise are still a prob-lem Make a similar trip between two houses in Alaska and you do not cause congestion The noise is likely to be heard only by the occasional stray caribou The dae caused by pollutants is much reduced, because e on driving is that each driver faces the costs of his actions, the rush-hour New York driver should paye turns out to be appropriate, if it is to reflect the truth, it should vary according to tie is not to discourage every-one froht inconvenience anyone else; it is to get them to take into account the inconvenience they cause to others To take an extree mountains, it is nice to be able to take in the natural beauty of the place in relative solitude, and so it'sto find the trails cluttered with other people Theyme, but it would not be efficient to forbid their trip because it gives them so much pleasure andneeds to strike the right balance between pleasure and trouble; it must reflect the cost of the externalitybut no more We should ais they enjoy, even if others are mildly incon-venienced, but also one where we all refrain fro them is small We discovered in chapter 3 that perfect markets deliver this world, at least within the sphere that markets operate Perfect markets can-not make us smile at passersby or love our faet a cappuccino if and only if we are willing to pay more than the true cost-which includes the cost in time and trouble of the baristas, the bean pickers, the entrepreneurs, the machine manufacturers, and the rest In other words, perfect s that we enjoy only if our enjoyhs the trouble caused to make it all possible

This is why econo well But we are also vigilant for the manywhether to drive across town, I can be sure that the benefit to hs the cost to everybody else? There's no need to worry about costs and benefits that are part of an efficientare perfect markets (contrary to popular belief, they are not far off), then the trouble it took to refine and distribute the gasoline is fully represented in the price I will not buy gasoline unless the benefit I get froreater than the trouble it took to refine and distribute

Instead, we should worry about costs and benefits asoline causes local poisoning and global ware when I burn a tank of gasoline is not caused to me or to the oil co drivers to pay all of the costs of their actions: since they have already paid the market costs to the oil company, they also need to pay, on top of that, the externality costs These external-ity costs are the costs inflicted on others but not borne by the driver or the oil con an externality charge We know that there may be costs and benefits that spill over froe, and if so, this will be inefficient (translation: we could do better,at least one person better off and nobody worse off) We also know that if ant to change behavior to correct the inefficiency, we need to address prices at the e prices Third, we do not need to worry about costs, which have been incorpo-rated into a well-functioning market transaction, only external-ity costs, which have been left out Fourth, ourshould reflect those externality costs accurately It's not enough simply to ban any behavior we don't like Instead, we should be focusing on cases where the active person gains se costs for others

Two objections to externality charges A charge for externalities is effectively a governovernes are often attacked froround

How much do people spend on fuel?

Percent of Income 6 5 4 3 2 1