The welfare impacts of a positive (consumption) externality

Back in 2023, I wrote a post about the welfare impacts of a negative consumption externality. I think I always meant to follow up that post with a companion post about the welfare impacts of a positive consumption externality, but I never did. So here goes!

To recap, an externality is the uncompensated impact of the actions of one person on the wellbeing of a third party. A positive externality makes the third party better off, while a negative externality makes the third party worse off. They are called externalities because they lie outside the original decision, i.e. some of the costs or benefits are external to the person whose action creates them.

There are fewer examples of positive externalities that come readily to mind than negative externalities, but let me use the example from my ECONS102 class: vaccinations. A person who gets vaccinated receives some benefit themselves, because they are less likely to get infected by whatever they have been vaccinated against. However, they also provide a benefit for other people (including those who are unvaccinated), because other people are less likely to catch the infection as well (because they are less likely to catch it from the vaccinated person).

Consider the market for vaccinations as shown in the diagram below. The market will operate at the quantity where supply (S) meets demand (D) - that is, the quantity traded will be QM, and the price of vaccinations will be PM.

However, the vaccine recipients create a positive externality for other people. Since this externality arises from the buyers of vaccinations, we show this externality on the demand side of the market - we refer to it as a positive consumption externality.[*] This means that the benefits that vaccine recipients receive themselves from getting vaccinated are lower than the benefits that society receives from those vaccinations - the difference is the benefit that is received by other people. We show this on the diagram by differentiating between the marginal social benefit (MSB) and the marginal private benefit (MPB). The MPB is the benefit that vaccine recipients receive for themselves. The MSB is the marginal private benefit, plus the benefit of the externality - the marginal external benefit (MEB).

Now, society prefers the quantity of vaccinations to be the quantity where marginal social benefit (MSB) is equal to marginal social cost (MSC) - I'll explain why a little later in this post. That is the quantity QS, and one way to get to the quantity QS is if the price of vaccinations decreased to PC (because then, more people would be willing to get vaccinated). Notice that in the diagram, relative to the quantity that society prefers (QS), the market produces too little (QM). There are too few vaccinations (or too few people getting vaccinated).

Why does society prefer QS (the quantity where MSB = MSC)? It's because that's the quantity that maximises economic welfare. Economic welfare is the sum of all of the net benefits arising from the market. First, the consumers receive some net benefit from participating in the market. Consumer surplus is the difference between the amount that consumers are willing to pay (shown by the demand curve), and the amount they actually pay (the price). In the diagram, at the equilibrium price and quantity, consumer surplus is the area FEPM. Second, producers receive some net benefit from participating in the market. Producer surplus is the difference between the amount the sellers receive (the price), and their costs (shown by the supply curve). In the diagram, at the equilibrium price and quantity, producer surplus is the area PMEH. Third, the third parties are positively affected by the market. The welfare benefit of the positive externality is the area in-between marginal social benefit and marginal private benefit, up to the quantity of vaccinations received (in this case, QM). That is the area AGEF, and it is added to total welfare. Total welfare is the sum of consumer surplus and producer surplus (which is the area FEH), plus the area of the positive externality (AGEF), and is equal to the area (AGEH).

Now consider the market operating at the quantity QS (with the price PC). The consumer surplus is the area FJPC. The producer surplus is tricky, because to get the market to produce QS, that would require the seller to accept a price that is below their costs (notice that the price PC is below the firms' costs shown by the supply curve). In reality, the government would probably subsidise this good to achieve the optimal outcome, but we will instead assume that the government mandates that the seller provide vaccinations at below cost, to anyone who is willing to pay the price PC (this might make some sense in a public health care system like New Zealand, but is still just a simplifying assumption rather than a description of how this would work in practice). The producer surplus is therefore the area -PCHBJ (it is all negative, because every vaccination is provided for a price that is below the sellers' costs). The area of the positive externality is the area ABJF. Total welfare at QS is equal to ABH.[**] Notice that this total welfare is larger when the quantity is QS than when the quantity is QM. If the market is left alone, there are too few vaccinations (or too few people getting vaccinated), and this decreases total welfare by the area GBE. That area GBE is the deadweight loss of the externality.

Since the market produces too little, a relevant question is how could we get the market to produce more? A Pigovian subsidy (named after 20th Century economist Arthur Pigou) is one option, since subsidies increase the quantity of a good that is traded (for more on that, see this post). Of course, determining the exact optimal quantity QS is difficult in practice. However, we can be sure that it isn't the quantity that is provided by the market.

*****

[*] In contrast, when producers produce a positive externality as a consequence of manufacturing other goods (for example), that is a positive production externality, which we would show on the supply side of the market. An example of a positive production externality is the smell of freshly baked bread emanating from a bakery (at least, it's a positive externality for those who like the smell of bread).

[**] Calculating total welfare involves adding the consumer surplus and externality (adding FJPC and ABJF gives the area ABJPC) and then subtracting the negative producer surplus of PCHBJ, which leaves the area ABH.

The costs of traffic noise

Traffic noise is an example of a negative externality - the impact of an action on a third party (a 'bystander') who has not consented to or played any role in the carrying out of that action. In this case, traffic noise caused by drivers on the road negatively affects people who live nearby, and those people haven't played any role in creating the noise.

To the extent that traffic noise negatively affects people living nearby, it should be reflected in property prices. Under hedonic demand theory, when someone buys a property they are really buying a bundle of characteristics of the property, one of which is the presence of traffic noise. Since traffic noise is a negative characteristic, we would expect properties that are exposed to more traffic noise to have lower prices, ceteris paribus (holding all else constant).

That means that the cost of traffic noise can be evaluated by carefully looking at the relationship between property values and traffic noise. That is what this 2025 NBER Working Paper (ungated here) by Enrico Moretti (University of California, Berkeley) and Harrison Wheeler (University of Toronto), sets out to do. They start by looking at the effect of roadside noise barriers on property prices, noting that these barriers provide an exogenous source of variation in traffic noise. They compare houses that are close to the barrier (within 500 metres directly away from the barrier) with those that are further away (between 500 and 1500 metres), using a difference-in-differences (DiD) strategy. That involves comparing the change in property prices between before and after the barrier was erected, between properties close to and those further away.

Moretti and Wheeler primarily use data from Florida, which provides details about the noise barriers that were completed, but also about barriers that were proposed but not completed. That also allows them to use a 'triple-differences' strategy, by matching areas that had a barrier erected, with those that didn't (but where one was proposed). Now, it turns out that the results from the triple-differences model are similar to the more standard DiD, but that should provide some further comfort with the robustness of the DiD results. The data on house prices and other characteristics comes from CoreLogic and covers the period from 1990 to 2022 (house prices) or 2006 to 2022 (property characteristics). Their final dataset includes nearly 600,000 home sales within 1500m of a noise barrier (and on the same side of the road as the barrier).

Focusing on their results that include parcel fixed-effects (so that time-invariant property characteristics are controlled for), Moretti and Wheeler find that:

For houses within 100 m of the barrier, the estimated effect increases to 8.59%. For houses 100–200 and 200–300 m from the barrier, the estimated effects increase to 5.79% and 4.41%, respectively. The effect on properties 300–400 m from the barrier is marginally statistically significant.

So, reducing traffic noise increases property values, and the effect is largest for properties closest to the road generating the noise. Beyond about 300 metres, the effect is statistically indistinguishable from zero, but within 300 metres, the construction of a noise barrier increases property values by between 4.41 and 8.59 percent. Moretti and Wheeler then note that:

Since our data report the construction cost of each barrier, we can compute the marginal value of public funds (MVPF), defined as the property value appreciation over costs... The average MVPF for barriers that were built amounts to 1.7, while the MVPF for barriers proposed but not built is 1.4. This is to be considered as a back-of-the-envelope calculation that ignores property taxes. Property taxes would reduce both the social benefits (since some of the home value increase gets taxed), and the social costs (since property taxes end up in local government coffers).

So, on this measure at least, noise barriers appear to be a good use of public funds, since the increases in property values exceed the costs of erecting the barriers (although noting that there may be other uses of public funds with even higher MVPF values).

Next, Moretti and Wheeler change their model in order to allow the change in price to vary based on the expected decibel reduction. They use a model where the effect is non-linear in noise reduction, and find that:

The effect plateaus at 10 dB of reduction, which represents the 96th percentile in our sample. The effect is estimated to be zero when noise reductions are 4.9 dB...

The average barrier in our sample reduces noise by 7.15 decibels. At this level of noise reduction, our estimates imply that the average price of a decibel is 0.94%...

That is the result that Moretti and Wheeler use later in their paper to estimate the economic cost of the externality. However, first they need to rule out some competing explanations for their effects. They show that air quality is somewhat better near to the barriers, but the effect is small and not statistically significant. They show that the results do not change when accounting for tree canopy or the presence of other buildings, meaning that noise barriers blocking views of the road is unlikely to explain the results. And, they show that the construction of new homes (with higher unobserved quality) does not explain the results.

Moretti and Wheeler next use their results to estimate the economic cost of the externality for each census tract in the US. From that, they find that there is:

...a negative correlation between the cost of the externality and median family incomes. The slope is -0.10 (0.01), indicating that a 10% lower income is associated with a 1% higher per capita cost. The correlations with the share of residents who are Black and the poverty rate are positive. The slopes are 0.08 (0.01) and 0.63 (0.05), respectively, indicating that a 10 percentage point higher share of Blacks or a 1 percentage point higher poverty rate are associated with 0.8% and 0.6% higher per-capita costs...

That means that the externality cost is regressive. That is, the cost of the externality is a larger proportion of income for low-income families than for higher-income families (taking into account the location of low-income and higher-income families and the property values where they live and the traffic noise they face).

In total, Moretti and Wheeler estimate the cost of traffic noise to be US$7.0 billion in Florida, and $109.75 billion for the US as a whole. Looking across cities, they find that per-capita traffic noise costs increase with urban share of the population and population density, which they suggest is because cities with greater urban share or those that are denser have both higher noise exposure, and higher property values.

Finally, Moretti and Wheeler estimate that a one-off Pigovian tax equivalent to US$974 per car would be equal to the marginal external cost of the traffic noise externality (noting that the optimal Pigovian tax is one that is equal to the marginal external cost). They also estimate the potential benefit of a move to 100 percent electric vehicles (which have lower engine noise) at US$5.39 billion for Florida, and $77.28 billion for the US as a whole.

This research tells us that traffic noise is a costly negative externality. Those costs are capitalised into property values and are borne disproportionately by lower-income households. Fortunately, the research also suggests that there are worthwhile ways of reducing those costs, including erecting noise barriers and rolling out more electric vehicles, and the benefits of those solutions may be substantial.

[HT: Marginal Revolution, last year]

Evidence that tradeable pollution permits can work

This week, my ECONS102 class covered externalities. As part of the topic, we spent a bit of time considering the economics of pollution control, where the government has three main options: (1) regulation (command-and-control); (2) Pigovian taxes; or (3) tradeable pollution permits. I've posted before about the latter two options (see here and here).

Tradeable pollution permits often attract attention from my students, as it seems surprising that granting polluters 'the right to pollute' might be an effective way of reducing pollution. However, economic theory suggests that this can be both an effective and a cost-effective way of reducing pollution. And the research reported in this 2025 article by Michael Greenstone (University of Chicago) and co-authors, published in the Quarterly Journal of Economics (ungated earlier version here), provides some compelling evidence that tradeable pollution permits are effective.

Greenstone et al. collaborated with the Gujarat Pollution Control Board (GPCB) in India to design and experimentally evaluate a particulate-matter emissions market, the first market of its type anywhere. They describe the experiment as follows:

GPCB launched the market for industrial plants in and around Surat, Gujarat, a rapidly growing city of 7 million people, in 2019. Under the command-and-control status quo, plants are mandated to install abatement equipment and are sporadically inspected in person by government regulators and auditors to check that they meet limits on the concentration of pollution emissions... For the present experiment, GPCB mandated a sample of 318 large, coal-burning plants to install continuous emissions monitoring systems (CEMS) to measure the total mass of particulate matter (PM) emitted, compared with the measurement under the status quo of pollution concentrations during spot visits... The emissions market experiment then randomly assigned 162 out of 318 plants to the market and 156 control plants stayed under the command- and-control regime.

The tradeable pollution permits market worked much as we describe in class:

GPCB set a cap on the total mass of particulates that could be collectively emitted by all treatment plants over a compliance period. They allocated permits to treatment plants, with permits summing to 80% of the cap distributed for free, in proportion to plant emissions potential, and 20% sold off in weekly auctions. Thereafter, treatment plants could trade permits with each other. At the conclusion of each compliance period, any treatment plant that did not hold enough permits to cover their emissions was subject to fines based on the size of the shortfall.

As I note in my ECONS102 class, the advantage of allowing pollution permits to be traded is that plants with relatively low abatement costs (low costs of reducing pollution) have an incentive to sell their surplus permits and abate pollution instead, while plants with relatively high abatement costs have an incentive to buy permits rather than undertake costly abatement. Transferability is one of the important features of efficient property rights, and having permits that are tradeable helps to ensure that.

Greenstone et al. look at compliance (did they have enough permits to cover their emissions), and then compare treatment and control plants in order to estimate the effect of the permit scheme on particulate emissions and variable abatement costs. They find that:

Treatment plants complied—held enough permits to cover their emissions—in 99% of plant-periods. By contrast, the compliance rate with concentration standards at baseline was 66%...

Second, the treatment reduced particulate emissions by 20%–30%, relative to control-plant emissions in the command- and-control regime...

Our third main finding is that the market reduced variable abatement costs by 11% at a constant level of emissions.

Taken altogether, those results provide strong field experimental evidence that the permits scheme worked as intended, that treatment plants were compliant, and that emissions decreased while also decreasing abatement costs. Greenstone et al. then conduct a cost-benefit analysis of an expansion of the market. Based on a range of assumptions on the mortality effects of particulate pollution, they estimate that the benefits of the market are at least 25 times larger than the costs. Needless to say, that suggests that tradeable pollution permits have been strongly worthwhile in this setting, and that they would be worth exploring in other settings as well. And in a postscript in the conclusion to the paper, Greenstone et al. note that the GPCB has launched another particulate market in the largest city in the state, Ahmedabad. So clearly, the GPCB was sufficiently convinced that they decided to extend the approach elsewhere.

[HT: Marginal Revolution, back in 2024]

Read more:

• The inefficiency of New Zealand's emissions trading scheme
• Pigovian taxes vs. tradeable pollution permits when clean technology becomes available
• The Greens vs. Labour on carbon emissions, taxes and permits

Positive network externalities and the value of social media

How much is social media worth? In an interesting article in The Conversation earlier this week, Peter Martin (Australian National University) discussed the value of social media networks:

Social media is a problem for economists. They don’t know how to value it...

As the Australian Senate prepares to hold an inquiry into the impact of social media, economists meeting in Adelaide at the annual conference of the Economic Society of Australia have been presented with new findings about the value of social media that point in a shocking direction. They suggest it is negative.

That’s right: the findings suggest social media is worth less to us than the zero we pay for it. That suggests we would be better off without it.

Wait, what? There's a good that we willingly use that has negative value? People may not be purely rational decision-makers, but that will take some explaining. Here's what Martin wrote about that study:

Leonardo Bursztyn of the University of Chicago presented the findings in the keynote address to the conference...

They surveyed more than 1,000 US university students, asking a series of questions about TikTok, Instagram and Google Maps (more about maps later).

The first set of questions was designed to ascertain how much they would need to be paid (or would be prepared to pay) to be off TikTok and Instagram for a month...

The answers suggest users value these platforms a lot, on average by US$59 per month for TikTok and $47 for Instagram. An overwhelming 93% of TikTok users and 86% of Instagram users would be prepared to pay something to stay on them...

Then Bursztyn and colleagues asked a second set of questions:

If two-thirds of the students on your campus sign up to deactivate, how much would you need to be paid (or be prepared to pay) to sign up too?...

Most of the TikTok users (64%) and almost half of the Instagram users (48%) were prepared to pay to be off them, so long as others were off them, resulting in average valuations across all users of minus US$28 for TikTok and minus $10 for Instagram.

Martin notes that:

The finding is a measure of the extent to which many, many users hate TikTok and Instagram, even though they feel compelled to use them.

I'm not so sure. Maybe users dislike TikTok and Instagram that much, but there is an alternative explanation, which relates to something I cover in my ECONS101 and ECONS102 classes: positive network externalities.

An externality is the uncompensated impact of the actions of one party on someone else (a bystander). A positive externality is an externality that makes the bystander better off. For example, if I plant a nice flower garden in the front of my house, it makes me feel happy, but it also makes people walking by happier as well. The flower garden creates a positive externality for the people walking by (the bystanders). The flower garden creates value for those walkers.

A network externality means that the value of belonging to a network depends (in part) on the number of other people using the network. A positive network externality is one where the larger the size of the network, the more value each network user receives from belonging to the network. Consider Facebook as an example. If you were the only user of Facebook worldwide, you've got a place to store photos, or you can post notes to yourself. So, it provides you some value, I guess. But the value of Facebook really comes about because you can interact with your friends there. The more of your friends on Facebook, the more value it creates for you. We could tell a similar story about Instagram, or TikTok.

Now, let's consider Bursztyn's results in the context of positive network externalities. When users of TikTok or Instagram were surveyed and asked how much they would have to be paid to stop using those services for a month, they had to be paid a lot. Clearly, those services do provide value to the consumers.

Next, when the users were asked how much they would have to be paid to give up TikTok or Instagram if two-thirds of the students on their campus sign up to deactivate, the value evaporated, and became negative for many users (let's call that the 'core value' that the social network provides). Why? Because if fewer of their friends are using Instagram or TikTok, then the value from the positive network externality is much lower. They are not willing to pay much if the service doesn't provide any core value (or even negative core value), because few or none of their friends are using it (and so any positive network externality isn't enough to make it worthwhile for them to use the social network).

In The Conversation article, Martin talks about "fear of missing out" as driving the results (and so do Bursztyn et al. in the research paper that Bursztyn's keynote was based on), and that may be true to some extent, but I think that frames the total value that social networks provide in a unnecessarily negative way. We have to remember that the whole purpose of social networks is networking - interacting with others. Without the interactive and community elements, a social network might as well just be a static website. Moreover, some users do receive core value from the social network, even without the positive network externalities. 

However, it is interesting that the service (excluding any positive network externalities) of Instagram and TikTok has negative core value for many (but not all) consumers. Those consumers demonstrating a negative core value wouldn't be using the social network if their friends weren't using it. This demonstrates that while particular social networks have a stranglehold on users' attention right now, that dominance is somewhat fragile. If a new service comes along that provides a higher core value, and attracts away a sufficiently large number of users, then that can cascade into a new dominant service. That is exactly what happened when Facebook took over the social network space from MySpace, Friendster, and Bebo. Or what TikTok may be doing to YouTube right now. And this creative destruction of the dominant firms is likely to be further promoted by the 'enshittification' of these products.

We could use results like Bursztyn's to argue that social networks are a bad thing, because they provide negative core value for many consumers. Or, we could recognise that overall they do provide value, because if they didn't, then consumers wouldn't use them. Just because that value comes from the fact that many other users are also using the same network, that doesn't mean that consumers don't want these products or value them. It's just that the value mostly comes from the network, not from the product. And if someone can make a better product and create a new valuable network, then consumers will move onto this next new shiny network instead.

Read more:

• How much money would you accept to give up Facebook for a month?
• What is Facebook worth to you?

Dealing with the Doritos crunch externality

This story on FoodDive last month made me laugh:

While PepsiCo’s Doritos chips are popular with gamers, the loud crunch they make has long been a source of frustration.

The beverage and snacking giant estimated that 85% percent of U.S. gamers have consumed Doritos in the past three months. But at the same time, nearly a third of individuals reported that other people’s crunching distracts them from playing well and impacts their performance.

To “help gamers keep the crunch to themselves,” Doritos is debuting what it calls “Doritos Silent.” Gamers download Doritos Crunch Cancellation software and when the technology is turned on, the software detects the crunching sounds and silences it while keeping the gamer’s voice intact.

So, PepsiCo has released software that will cancel the noise from crunching Doritos that disturb other gamers. This is very overdue! [*] There is a serious side to this story though - PepsiCo has helped to reduce a negative externality problem.

An externality is the uncompensated impact of the actions of one person on the wellbeing of a third party. Externalities can be negative (they make the third party worse off) or positive (they make the third party better off). We call them externalities because they lie outside the decision that created them - that is, some of the costs or benefits are external to the person whose action creates them. In this case, the gamer eating Doritos imposes a cost on other gamers, who have to suffer the loud crunching noise over their headsets - it is a negative externality. Relative to the socially optimal level of Doritos eating by gamers, gamers will eat too many Doritos, since some of the costs of their Dorito-eating are passed onto other gamers.

Now, the Coase Theorem (named for the late Nobel prize-winner Ronald Coase) suggests that, if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own (that is, without government intervention). However, notice the key phrase here is 'without cost'. When you have many gamers interacting with each other, some (many) of whom consume Doritos, then it will be quite a complex task to get all parties to agree to a solution to this externality problem. When there are many parties to an agreement, the transaction costs (specifically, coordination costs) of arrive at the agreement will be high. So, they would hardly be bargaining without cost, we therefore can't rely on the Coase Theorem.

If private parties can't solve the externality problem themselves, that usually means we must rely on a public policy solution. That is, the government would need to step in. But not in this case. Enter PepsiCo, and their Doritos-noise-cancelling software. If gamers can't hear the Dorito crunches of other gamers, then the negative externality is eliminated.

Now the question is, will they release an update to eliminate Cheetos noise, or the noise of slurping a Pepsi?

[HT: Marginal Revolution]

*****

[*] It turns out that Discord did something similar a few years ago.

Antimicrobial resistance vs. climate change

Careful readers of yesterday's post on antimicrobial resistance might wonder whether I also prefer regulation as a solution for climate change. After all, the problems are superficially similar. Both antimicrobial resistance and climate change are listed among WHO's top ten global public health threats, and both involve negative externalities (where one person's actions make others worse off). Both problems will require concerted international action to properly address.

However, there is an important distinction between the two problems, which means that taxes or tradeable permits (such as the Emissions Trading Scheme) are likely to be effective solutions to climate change, but are less effective for antimicrobial resistance. That distinction may have gotten a little bit lost in yesterday's post.

In the case of climate change, all reductions in carbon emissions are good, in terms of reducing future climate change. So, any policy instrument that reduces carbons emissions is moving us towards the 'optimal' level of carbon emissions (which is not zero gross emissions - all of us emit carbon dioxide when we breathe, for example). The question then becomes, how do we reduce those emissions at the lowest cost to society? Taxes and tradeable permits are credible options for reducing emissions at the lowest cost, while regulation is not (a point that Eric Crampton has made many times, such as here).

Unlike carbon emissions, reducing all antibiotic use is not a good thing. Antibiotics are still needed to deal with infections. So, taxes and tradeable permits are not good instruments for reducing the problem of antimicrobial resistance, because we shouldn't want to reduce all antibiotic use, only inappropriate antibiotic use. So, as I noted in yesterday's post, antibiotic use in agriculture is an appropriate target for a tax to reduce use, but taxing all antibiotics used in medical care would likely make us all worse off.

Sometimes, regulation may actually be the best available option. But that sure doesn't mean that regulation is always the best available option.

Read more:

• Antimicrobial resistance, and health care as a negative externality

Antimicrobial resistance, and health care as a negative externality

In 2019, the World Health Organization declared antimicrobial resistance one of the top ten global public health threats facing humanity. The idea that antibiotics may soon be ineffective, making relatively minor infections life-threatening again (as they were before antibiotics became widely available after World War II) is frankly scary. This is definitely a public health issue to watch.

The Conversation has a series of articles on antimicrobial resistance, published less frequently than is probably warranted. However, they have had a couple of articles in the last week, and this article in particular caught my attention, by Allen Cheng (Monash University):

The concept of antibiotics as a valuable resource has led to the concept of “antimicrobial stewardship”, with programs to promote the responsible use of antibiotics. It’s a similar concept to environmental stewardship to prevent climate change and environmental degradation.

Antibiotics are a rare class of medication where treatment of one patient can potentially affect the outcome of other patients, through the transmission of antibiotic resistant bacteria. Therefore, like efforts to combat climate change, antibiotic stewardship relies on changing individual actions to benefit the broader community.

An externality is the uncompensated impact of the actions of one or more people on a third party (a bystander). Externalities can be positive (they make the third party better off), or they can be negative (they make the third party worse off). Usually, economists think of health care as exhibiting positive externalities. Think about a vaccination for an infectious disease. It makes the person getting vaccinated better off, because they are less likely to get sick. It also makes other people better off, because they are also less likely to get sick (because there is one more vaccinated person who cannot pass on the infectious disease).

However, what Cheng is suggesting is that, in some cases, antibiotic use may create a negative externality, because one person using antibiotics in the wrong way increases the chances that an antibiotic-resistant bacteria emerges, which would make other people sick (and potentially, unable to be easily treated). So, while some aspects of health care have positive externalities, this seems like an example where the externality is negative.

What is to be done? Cheng suggests:

There is a lot we can do to prevent antibiotic resistance. We can:

• raise awareness that many infections will get better by themselves, and don’t necessarily need antibiotics

• use the antibiotics we have more appropriately and for as short a time as possible, supported by co-ordinated clinical and public policy, and national oversight

• monitor for infections due to resistant bacterial to inform control policies

• reduce the inappropriate use of antibiotics in animals, such as growth promotion

• reduce cross-transmission of resistant organisms in hospitals and in the community

• prevent infections by other means, such as clean water, sanitation, hygiene and vaccines

• continue developing new antibiotics and alternatives to antibiotics and ensure the right incentives are in place to encourage a continuous pipeline of new drugs.

Some of these suggestions may be more effective than others. However, I want to take a step back and see what is in the economists' toolkit for dealing with negative externalities. We need to recognise, though, that unlike canonical negative externalities like air pollution, the goal here is not to reduce all antibiotic use, but only to reduce inappropriate antibiotic use.

We can start by setting aside bargaining solutions to the externality. There are simply too many parties involved (all patients prescribed an antibiotic, all doctors, and all farmers who may want to use antibiotics) for a general agreement on antibiotic use to be negotiated. That leaves public solutions, which really comes down to command-and-control policies (that is, regulation), or market-based policies (for example, taxes).

Let's start with taxes. Taxes increase the price to consumers, and decrease the effective price received by producers, and therefore create incentives for less to be produced and consumed. That would be a good solution if we were interested in reducing antibiotic use in general, but that isn't the goal here. Except in one case, which is farm use of antibiotics. Taxing antibiotic use in agriculture, would reduce the use of antibiotics, and would probably be effective. The higher costs of production (arising from the greater direct cost of raising animals, as well as the greater indirect cost as less antibiotic use slows animal growth rates) would likely be passed onto the consumers of animal products, as well as reducing farm profits.

In the health sector though, regulation is the only remaining policy alternative. The first two of Cheng's suggested solutions fit in here - raising awareness and using antibiotics more appropriately. It does appear that governments are attempting these solutions already (for example, see here for the advice provided by New Zealand's Ministry of Health, or here for the advice provided by the Australian Government). Providing advice and recommendations is about as weak as policy can get. It is unlikely to drive substantial change. For one of the top ten global public health threats, governments should be doing more to reduce the inappropriate use of antibiotics.

I'm not usually in favour of adding layers of bureaucracy, all of which come with attendant costs. However, in this case the national oversight part of Cheng's recommendations is important. This could be implemented through initially tracking antibiotic prescriptions, then a program of random audits of patient records to ensure prescriptions are warranted, and the most appropriate antibiotic (based on what was known at the time) was prescribed. The tracking component need not be too onerous, because this information is already captured. Audits would require some funding (presumably through Te Whatu Ora Health New Zealand), but as cumulatively more audits are conducted, the audits could become better targeted over time towards unusual patterns of antibiotic prescription.

Antibiotic resistance is a serious public health concern, and is a negative externality arising from inappropriate antibiotic use. This is something that can be addressed, and should be.

[Update: I wrote a brief follow-up to this post]

The evils of academic bureacracy and bullshit work

Every now and again, you read something and feel like screaming out: "Oh my God, yes!". That was my reaction to this article in The Conversation a few weeks ago, by Meg Elkins (RMIT University), Ananta Neelim, and Robert Hoffman (both University of Tasmania). They open the article with:

Are you spending more and more time at work doing paperwork and filling in forms rather than the thing you were trained and hired for? Does this busy work often seem to resist rational purpose or questioning? Does it kill your productivity, initiative, motivation and, frankly, your self-worth and sanity?

At that point, I am thinking, you should talk about academia. In fact, that was their go-to example:

Although stories of creeping bureaucracy abound in many industries, evidence – and our own experience – suggests nowhere has the problem of red tape exploded as much as it has in universities.

Staff complain the time they have for teaching and research is being eaten up by filling in forms and writing reports of questionable value. But this gripe goes beyond the inefficiency of bureaucratic excess. Some rules demotivate because they are interpreted as patronising.

I encourage you to read the entire article, especially if you are a current student and you're wondering why academic staff aren't always as fully prepared for lectures or assessments as you would like, aren't always available, or don't always spend the time to have the time to give you all the one-on-one attention that you need. It's not because they don't care. It's literally because there are so many bureaucratic roadblocks, and so much bullshit work that gets in the way (and I loved that Elkins et al. referenced David Graeber's excellent book Bullshit Jobs, or rather the article that led to the book [*]). Time and energy are limited resources, after all.

As for me, I don't find it all that demotivating, dealing with all the bullshit work, just frustrating. I would much rather spend my time on teaching and research activities, than filling in forms, attending meetings (especially meetings about meetings), and completing formative research evaluations (as practice for real research evaluations).

The problem here is one of negative externalities. The bureaucrats and academic managers who devise the systems and processes that academics must follow only face a small proportion of the total cost of their systems and processes. Those systems and processes instead impose most of the costs on academic staff (and academic administration staff). The total cost of the systems and processes (the marginal social cost) far exceeds the small costs that the bureaucrats and academic managers face themselves (the marginal private cost). And so, we end up with more complicated, onerous, and unnecessary systems and processes than would be optimal. The optimal quantity of form-filling is much less than the unrestrained quantity - notice the similarity to the negative externalities I wrote about last week.

Is it time for academics to fight back against bullshit work? Sadly, Elkins et al. don't have much to offer on that. Their main hope appears to be that academic leaders will learn from the experience of others in cutting red tape. Unfortunately, that would mean that someone would have to lead the way. I don't see too many exemplars of that in practice.

As a group, academics are not powerless. However, the staff unions seem unconcerned with the unending rise of bullshit work, at the expense of teaching and research. They are more focused on fighting continuing below-inflation increases in salaries, and increasingly precarious work conditions. The irony is that there might be more funds for paying higher salaries, and more job security, if so many of us weren't spending so much time on bullshit work.

Individually, some academics are able to negotiate around a small proportion (but definitely not all) of the red tape, perhaps by having academic administrators or junior academic staff complete some of the tasks that would otherwise fall to them. Unfortunately, that has the effect of increasing the inequality between senior staff and top researchers (who can negotiate those deals) and junior and emerging staff (who cannot, and may end up carrying some of the burden for senior staff). Those senior staff really need to stand up for the junior staff who are being burdened with bullshit work, but the individual incentives to do so are all wrong. The principle is sort of like this:

Except, senior academic staff are forgetting the part about helping others. It is time to start.

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[*] I reviewed David Graeber's book here.

Using a Pigovian tax to correct for a negative (consumption) externality

In my previous post, I demonstrated that, if left alone, a market with a negative externality produces too much of a good, and creates a deadweight loss. At the end of that post, I noted that, if we wanted to reduce the quantity that is traded in the market, we could use a tax. Such a tax is called a Pigovian tax (named after 20th Century economist Arthur Pigou), and is the focus of this post.

Consider the same market as that previous post (the market for fireplaces, or fireplace use), as shown in the diagram below. The market operates at the point where supply (S) meets demand (D) - that is, the quantity traded will be QM (and the price of fireplaces, or fireplace use) will be PM. Consumer surplus is the area ACPM, producer surplus is the area PMCF, the welfare cost of the negative externality is the area ACHG, and total welfare (which is the sum of consumer surplus and producer surplus, minus the area of the negative externality) is equal to the area (GEF-ECH).[*]

Now consider what happens when the government imposes an excise tax on fireplaces (or fireplace use). We will assume that the per-unit cost of the tax is exactly equal to the marginal external cost (MEC), and that the tax would be paid to the government by the sellers of fireplaces (or fireplace users). We represent the tax with a new curve, S+tax, which is exactly the same distance above the supply curve as the MSB curve is below the demand curve (that's because the tax is exactly equal to MEC). The price that consumers pay increases to PC. The effective price that producers receive (after paying the tax to the government) decreases to PS. The quantity of fireplaces (or fireplace use) decreases to QS.

What happens to economic welfare? The consumer surplus is the area ABPC, and the producer surplus is the area PSEF. The government receives tax revenue equal to the area PCBEPS (this is part of total welfare, because the government can use that revenue to provide services like schools or hospitals). The area of the negative externality is the area ABEG. Total welfare with the tax is equal to GEF. [**]

In other words, the Pigovian tax not only reduces the quantity of fireplaces (or fireplace use), but leads to an increase in total welfare (in fact, it leads to total welfare being maximised and the deadweight loss being eliminated). Economists aren't often in favour of excise taxes, but this is one case where an excise tax can make society better off.

Read more:

• The welfare impacts of a negative (consumption) externality

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[*] For the explanation of these welfare areas, see my previous post.

[**] Note that this is the same total welfare as occurred at the quantity QS in my previous post. To recap, that's because the area of the negative externality ABEG cancels out some of the total welfare that was in the combined consumer and producer surpluses and government revenue (ABEF), leaving the area GEF.

The welfare impacts of a negative (consumption) externality

As I noted earlier this week, an externality is the uncompensated impact of the actions of one person on the wellbeing of a third party. A positive externality makes the third party better off, while a negative externality makes the third party worse off. They are called externalities because they lie outside the original decision, i.e. some of the costs or benefits are external to the person whose action creates them.

The most common example that economists use to explain negative externalities is pollution. For example, from this New Zealand Herald article from earlier this year:

Two air pollutants are quietly contributing to thousands of premature deaths in New Zealand every year, shows a new analysis that’s prompted fresh calls for tougher regulations.

While New Zealand’s air quality is generally considered good by international standards, Stats NZ’s newly updated indicator has linked pollution from vehicles and fireplaces to around nine times more early deaths than last year’s road toll.

People running vehicles or fireplaces are creating a negative externality for other people - an increased risk of death from poor air quality. Let's focus on fireplaces and show that, left alone, the market will lead to too much use of fireplaces. Consider the market for fireplaces (or fireplace use) as shown in the diagram below. The market will operate at the quantity where supply (S) meets demand (D) - that is, the quantity traded will be QM and the price of fireplaces (or fireplace use) will be PM.

However, the fireplace users create a negative externality for other people. Since this externality arises from the buyers of fireplaces (or fireplace users), we show this externality on the demand side of the market - we refer to it as a negative consumption externality.[*] This means that the benefits that fireplace users receive themselves from operating their fireplaces are higher than the benefits that society receives from those fireplaces - the difference is the negative benefit that is imposed on other people through air pollution. We show this on the diagram by differentiating between the marginal social benefit (MSB) and the marginal private benefit (MPB). The MPB is the benefit that fireplace users receive for themselves. The MSB is the marginal private benefit, minus the cost of the externality - the marginal external cost (MEC).

Now, society prefers the quantity of fireplaces (or fireplace use) to be the quantity where marginal social benefit (MSB) is equal to marginal social cost (MSC) - I'll explain why a little later in this post. That is the quantity QS, and one way to get to the quantity QS is if the price of fireplaces (or fireplace use) decreased to PS (because then, sellers would not be willing to sell so many fireplaces). Notice that in the diagram, relative to the quantity that society prefers (QS), the market produces too much (QM). There are too many fireplaces (or too much fireplace use).

Why does society prefer QS (the quantity where MSB = MSC)? It's because that's the quantity that maximises economic welfare. Economic welfare is the sum of all of the net benefits arising from the market. First, the consumers receive some net benefit from participating in the market. Consumer surplus is the difference between the amount that consumers are willing to pay (shown by the demand curve), and the amount they actually pay (the price). In the diagram, at the equilibrium price and quantity, consumer surplus is the area ACPM. Second, producers receive some net benefit from participating in the market. Producer surplus is the difference between the amount the sellers receive (the price), and their costs (shown by the supply curve). In the diagram, at the equilibrium price and quantity, producer surplus is the area PMCF. Third, the third parties are negatively affected by the market. The welfare cost of the negative externality is the area in-between marginal social cost and marginal private cost, up to the quantity of fireplaces (or fireplace use) traded (in this case, QM). That is the area ACHG, and it is subtracted from total welfare. Total welfare is the sum of consumer surplus and producer surplus (which is the area ACF), minus the area of the negative externality (ACHG), and is equal to the area (GEF-ECH).[**]

Now consider the market operating at the quantity QS (with the price PS). The consumer surplus is the area ABEPS, the producer surplus is the area PSEF, and the area of the negative externality is the area ABEG. Total welfare at QS is equal to GEF.[***] Notice that this total welfare is larger when the quantity is QS than when the quantity is QM. If the market is left alone, there are too many fireplaces (or too much fireplace use), and this decreases total welfare by the area ECH. That area ECH is the deadweight loss of the externality.

Since the market produces too much, a relevant question is how could we get the market to produce less? A Pigovian tax (named after 20th Century economist Arthur Pigou) is one option, since taxes reduce the quantity of a good that is traded (for more on that, see this post). Requiring permits for fireplaces would be another way to limit the number of fireplaces to QS. Of course, determining the optimal quantity QS is difficult in practice. However, we can be sure that it isn't the quantity that is provided by the market.

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[*] In contrast, when producers produce pollution as a consequence of manufacturing other goods (for example), that is a negative production externality, which we would show on the supply side of the market.

[**] Notice that the area of the negative externality ACHG first cancels out all of the total welfare that was in the area ACEG, leaving the area ECH left over. That's why only GEF is left, while ECH is left subtracting from total welfare.

[***] Notice that the area of the negative externality ABEG cancels out some of the total welfare that was in the combined consumer and producer surpluses (ABEF), leaving the area GEF.

Forestry slash, externalities, and the Coase Theorem

This week my ECONS102 class is covering externalities. An externality is the uncompensated impact of the actions of one person on the wellbeing of a third party. Externalities can be negative (they make the third party worse off) or positive (they make the third party better off). We call them externalities because they lie outside the decision that created them - that is, some of the costs or benefits are external to the person whose action creates them.

An example of a negative externality from earlier this year was the damage caused by forestry slash. As Bryce Edwards summarised in the New Zealand Herald in February:

The weather events of January and February have caused a horrific toll, yet much of it was avoidable. The destruction caused by the storms was made much worse by the way forestry operations have changed the land in places on the East Coast of the North Island.

One of the biggest problems is the litter foresters leave behind when they harvest pine trees. The industry terms the branches and debris left to rot on the hillsides as “slash”, and in large storms this litter is prone to be washed down rivers, causing mayhem. The debris forms dams and diverts the flow of water, flooding towns and farms, and knocking out bridges and roads. In Cyclone Gabrielle the impact of slash was enormous...

The Herald’s Fran O’Sullivan wrote in the weekend about the logging problem, concluding “what we have observed over the past fortnight simply puts New Zealand in the Third World category”. This is because in other developed countries, the slash problem is better regulated or even banned. It’s a problem that has been known about for many years, and yet in New Zealand, the politicians have done virtually nothing about it, leaving society to pay for the damage caused by it.

The fact that the forestry companies can cause such great damage without being held accountable for the cost has astounded many. After all, citizens can be fined up to $5000 under the Litter Act 1979, and if the litter endangers anyone, the fine increases and can include imprisonment.

One way of understanding the forestry slash situation, and the options available for dealing with the negative externality, is to apply the Coase Theorem. This theorem, named after 1991 Nobel Prize winner Ronald Coase, states that if private parties can bargain without cost over the allocation of resources, then they can solve the problem of externalities on their own (that is, without government intervention).

The Coase Theorem forces us to recognise that both parties (the one causing the externality, in this case the forestry operators; and the one affected by the externality, in this case the affected property owners) have rights. In this case, the forestry operators have the right to operate their forestry business as they wish (which includes leaving slash on their land). The affected property owners have the right to the quiet enjoyment of their property, which includes the right not to face the risk of damage from forestry slash. These rights are in conflict with each other.

The solution to the externality problem under the Coase Theorem crucially depends on the allocation of entitlements - that is, which rights (those of the forestry owners or those of the affected property owners) are overriding - the overriding rights are those that receive the higher protection under the law. The solution to the externality problem will be different depending on whether the overriding rights belong to the forestry owners or the affected property owners. Let's work it through from both possible perspectives. However, remember that any agreement here would have had to have been made before the cyclone caused the damage.

First, let's say that the overriding rights belong to the affected property owners - their right to quiet enjoyment (and protection from the risk of forestry slash) will be protected. The default solution is that the forestry owners must not allow slash to affect other properties. They must dispose of it in some way, or otherwise prevent it from moving off their property. The alternative solution is that the forestry slash stays, but the forestry owners agree to compensate any affected property owners for the value of the risk that their property might be damaged by forestry slash. Notice that this is about the value of the risk of damage, as evaluated by the property owners. It will depend on the probability that forestry slash causes damage, and the cost of the damages that would be suffered if forestry slash causes damage. For simplicity, let's refer to it as the expected damage. The amount of compensation that the forestry owners would have to pay would have to be at least as much as the expected damage (otherwise the property owners wouldn't agree, and they don't have to, since under the default solution there would be no risk). However, the compensation also has to be less than whatever the forestry owners value the savings to be had from leaving forestry slash on the property rather than removing it or preventing it from moving off their property (otherwise, the forestry owners would be better off dealing with the forestry slash, rather than paying the compensation).

Now let's look at it the other way. Let's say that the overriding rights belong to the forestry owners - their right to operate their forestry business as they wish will be protected. Now, the default solution is that the affected property owners have to put up with the damage from forestry slash, or maybe they buy insurance to protect themselves. The alternative solution is that the affected property owners pay the forestry owners to dispose of the forestry slash (or prevent it from moving off their property). In this case, the amount of compensation would have to be at least as much as whatever the forestry owners value the savings to be had from leaving forestry slash on the property rather than removing it or preventing it from moving off their property (otherwise the forestry owners wouldn't agree, and they don't have to, since under the default solution the property owners just has to put up with the risk from forestry slash). However, the compensation also has to be less than the expected damage (otherwise, the property owners would be better off putting up with the risk, rather than paying the compensation).

The Coase Theorem tells us how a bargaining solution could arise when there is an externality problem. However, it requires both parties to reach an agreement, and in this case the agreement would have to have occurred before the cyclone. That didn't happen, and for very good reason. The solutions that the Coase Theorem proposes rely on the absence of costs. That means no bargaining costs (the costs that parties incur in the process of agreeing and following through on an agreement) and no monitoring and enforcement costs (the costs of ensuring that the agreement is followed through with). In this case, the bargaining costs would be prohibitively high, particularly because of coordination problems - there are so many potentially affected property owners that it would be difficult for all parties to agree on a solution.

So, with no bargaining solution in place, we were left with the default solution. The allocation of entitlements here appears to have been that forestry owners had the overriding rights, because it appears that the property owners were simply asked to put up with the damages, or await payouts from insurance or from the government. Moreover, there has been no expectation of compensation from the forestry owners. When private bargaining solutions fail to develop, then dealing with an externality problem necessarily falls to the government.

And this is what has made people angry. The negative externality was foreseeable (in fact, it wasn't even the first time this has happened). It existed even before the cyclone struck, although merely as a small risk of damage. However, the allocation of entitlements, which gave the forestry owners overriding rights, only became obvious after the cyclone struck. In other words, the allocation of entitlements didn't seem to matter, until it did. In hindsight, banning forestry slash from being left on properties would have been one potential public solution to deal with the problem.

This should make us wonder how many other similar situations exist, where innocent property owners might suddenly find themselves facing damages arising from other property owners doing currently lawful things. There are likely to be many such situations where bargaining costs are too high to allow a private solution to emerge to deal with the negative externality of expected damage. Forestry slash is easily frowned on in hindsight, but other situations may be even less clear as to the need for government intervention. However, as severe weather events become more common, these situations are likely to arise more often over time, and public solutions to the externality problem will only become more important.

Network externalities and electric vehicle subsidies

The government's Clean Car Discount scheme has been in the news this week. As Stuff reported:

The Government is changing the Clean Car programme to increase fees slapped on higher emitting vehicles, changing the rebates for zero emissions imports and lowering the threshold for eligible vehicles.

The changes come as the scheme was “successfully exceeding industry and government projections”, Transport Minister Michael Wood said, after it was reviewed a year into its full implementation.

It is timely to remind ourselves of the positive and negative aspects of a subsidy. A subsidy leads to a deadweight loss (as I outlined in the footnotes to this post from 2021 when the electric vehicle (EV) subsidy scheme was introduced). That is, there is a loss of economic welfare associated with a subsidy. However, as I noted in that same footnote:

...this assumes that there are no positive externalities associated with electric vehicles, which there probably are - a person buying an EV is a person not buying a carbon-powered vehicle, and so each EV sold reduces carbon emissions (and reducing a negative externality is the equivalent of a positive externality).

It is possible that a subsidy on a good that has a positive externality (or that reduces a negative externality) could increase total welfare. However, that is not the only reason that we might favour a subsidy for EVs.

Think for a moment about the infrastructure that exists to support petrol vehicles. In most towns and cities, there are many petrol stations where cars can refuel. It is very easy and inexpensive for a petrol vehicle owner to find somewhere to refuel. Now think about the corresponding situation for electric vehicle owners. Although there are electric vehicle charging stations around (in mall carparks, for example), the infrastructure is nowhere near as available as it is for petrol vehicles. An EV owner faces a more difficult and costly (in time and effort) exercise to charge their vehicle away from home.

Clearly, the fact that there are few places to charge EVs means that there is not as much incentive for firms to provide EV charging as there is to provide petrol refueling. Most of the reason for a lack of EV charging infrastructure is simply a lack of demand. However, there is a bit of a chicken-and-egg problem here. If there are few places to charge EVs, then few consumers will buy EVs. And if few consumers buy EVs, then there is little incentive [*] for firms to provide EV charging stations. In other words, there are positive network externalities across these two goods (EVs, and EV charging stations). The more EVs there are, the more profitable it is for a firm to provide EV charging stations. The more EV charging stations there are, the more value there is for each EV driver, since they can more easily find somewhere to charge their vehicle.

Subsidising electric vehicles may help us to get out of this chicken-and-egg situation. Having more EV owners (because EVs are less expensive as a result of the subsidy) creates incentives for firms to build out the charging infrastructure necessary to support EVs. The subsidy acts as a kickstart for the process of building more EV charging stations, which then makes it easier to own an EV, which incentivises more charging stations, and so on. The process snowballs. So, quite aside from any argument associated with environmental externalities, there is an argument to be made for a subsidy.

However, what is not at all clear is whether this is the right subsidy to achieve the goal of kickstarting an EV-charging snowball. The same outcome could be achieved by subsidising the EV charging stations, rather than the EVs. Subsidising EV charging stations might even be less costly for the government, as it would mean dealing with fewer subsidy recipients (reducing the transaction costs of the subsidy). That is the approach adopted in the US, where Tesla is making its charging network available to owners of EVs from other manufacturers, in order to receive a subsidy from the US government.

The key difference between the two subsidy options is political. Subsidising consumers to buy EVs provides a handout to voters (or at least, to voters who buy EVs). Subsidising firms to build EV charging stations provides a handout to firms. Handouts to voters play out much differently in the media than handouts to firms. It should be little surprise then, that a government might prefer to subsidise EVs rather than EV charging stations, even if subsidising the charging stations would be less costly for the same outcome.

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[*] Note that there isn't no incentive for firms to provide EV charging stations. Firms with environmental goals, or firms that want to look like they are supporting green causes, may provide EV charging stations even if there is little demand for them.

Read more:

• Who will really gain from the electric vehicle subsidy?

Incentivising coronavirus vaccination

A couple of weeks ago, my ECONS102 class covered externalities. An externality is the uncompensated impact of the actions of one person on a bystander. Externalities can be negative (and make the bystander worse off), or positive (and make the bystander better off). One of the examples I use for a positive externality is vaccines. A person who gets vaccinated makes themselves better off (by reducing their chance of getting sick), but also makes others better off (because there is at least one fewer person who they can get sick from) - that's a positive externality.

The problem with positive externalities is that the market, left on its own, will not ensure that enough is produced or consumed. That's because the market participants don't have an incentive to take into account the benefits that their actions confer on others. That market will produce too little, compared to the quantity that maximises societal welfare. In the case of vaccines, too few people would get vaccinated.

There needs to be some mechanism to encourage more people to purchase goods with positive externalities. One way is to subsidise them (for example, see this post about subsidising education). The subsidy effectively increases the benefits of selling the good or service (if it is paid to the sellers), or reduces the cost of the good or service (if it is paid to the buyers). Either way, it increases the amount that is produced and consumed, and can ensure the quantity is increased to the socially optimal quantity.

Alternatively, the government could find some other way to incentivise more production and consumption. Right now, we're in a situation where governments want to roll out coronavirus vaccines in the face of a substantial amount of vaccine hesitancy. Some governments have started to incentivise vaccines through more than just subsidising them and making them available for free. For example, the New York Times reported last month that:

West Virginia will give $100 savings bonds to 16- to 35-year-olds who get a Covid-19 vaccine, Gov. Jim Justice said on Monday.

There are roughly 380,000 West Virginians in that age group, many of whom have already gotten at least one shot, but Mr. Justice said he hoped the money would motivate the rest to get inoculated, as “they’re not taking the vaccines as fast as we’d like them to take them.”

Some people worry that giving monetary incentives reduces intrinsic motivation. Indeed, this famous research by Uri Gneezy and Aldo Rustichini (ungated version here) showed that fining parents for picking up their children late from a childcare centre encouraged more late pickups. When the moral incentive to pick up on time is replaced by a financial incentive, it turned out to be less effective. The corollary for vaccines is that paying people to get vaccinated could encourage fewer of them to do so.

However, to counter that argument UCLA has run some experiments showing that monetary incentives are effective, as reported by the New York Times a couple of weeks ago:

In recent randomized survey experiments by the U.C.L.A. Covid-19 Health and Politics Project, two seemingly strong incentives have emerged.

Roughly a third of the unvaccinated population said a cash payment would make them more likely to get a shot...

Similarly large increases in willingness to take vaccines emerged for those who were asked about getting a vaccine if doing so meant they wouldn’t need to wear a mask or social-distance in public, compared with a group that was told it would still have to do those things.

So, perhaps we don't need to worry so much about whether the monetary incentive would be effective. And, perhaps we wouldn't have to pay it to everyone. CBS News reported yesterday:

Health officials in Ohio have reported a surge in the amount of people getting their first COVID-19 vaccination shots, a week after Ohio Governor Mike DeWine announced the $5 million "Vax-a-Million" lottery.

Just days after DeWine said the state would award five vaccinated residents $1 million each in order to raise vaccination percentages, the Ohio Department of Health reported more than 113,000 people received their first dose of the vaccine.

Based on preliminary data, the department said the recent period showed a 53% week-to-week increase (May 13 to 18) compared to the time period before the announcement, where 74,000 people received their first dose (May 6 to 11). 

"We are seeing increasing numbers in all age groups, except those 80 and older, who are highly vaccinated already," said Ohio Dept. of Health director Stephanie McCloud. "Although the rate among that group is decreasing, it is doing so at a less rapid pace, demonstrating some positive impact even in that group."

Ohio residents 18 and older who have received at least one dose of the vaccine can enter to win one of the five $1 million prizes. Ohioans between the age of 12 and 17 who have received at least one dose of the COVID-19 vaccine can enter to win one of five four-year, full-ride scholarships to any state college or university in the state. So far, approximately one million entries have been collected, according to Ohio Lottery and Ohio Department of Health.

Gamifying vaccination by attaching it to a lottery is kind of inspired. If people who are the least risk averse are those who are least likely to get vaccinated, and also those who are most likely to play the lottery, then this could be incredibly effective in increasing vaccination rates. People constantly overestimate the chance of events happening that have small probabilities (this is one of the key features of what is called prospect theory), like winning the lottery. So, government wouldn't necessarily have to ensure that the lottery amount was high enough to ensure that it captures all of the social benefits of vaccination, making this solution more cost effective than paying everyone who got vaccinated. For example, paying 100,000 people $100 each to get vaccinated costs $10 million. But, government could possibly offer five prizes of $1 million each and get the same outcome of 100,000 people getting vaccinated for half the total cost.

Overall, New Zealand's approach to vaccination is slow and steady. We're ahead of target (see the New Zealand Herald's Vaccine Tracker), but there is a fair amount of concern about whether we will achieve the overall target (e.g. see comments here or here). There seems to be plenty of demand for vaccines right now, but if things start to slow up later, perhaps we need our own vaccine lottery?

[HT: Marginal Revolution for the NY Times article on incentives; The Dangerous Economist for the article on Ohio's lottery]

Should fossils be treated like shipwrecks?

In a new article published in the journal Contemporary Economic Policy (ungated earlier version here), Paul Hallwood and Thomas Miceli (both University of Connecticut) discuss the law and economics of paleontological discovery - that is, fossil hunting. Hallwood and Miceli note that there are three groups of fossil collectors that have different incentives, in terms of the search for fossils and/or the recovery of scientific knowledge (the public value) from those fossils:

...professional paleontologists, commercial collectors who look to sell finds for a profit, and amateur collectors who do it out of interest rather than profit.

One important point is that recovering fossils leads to both public and private value:

Private good value is realized when the pecuniary value of a fossil is realized, or if it enters directly into a private collection; public good values are created when a fossil-type and the information associated with it are added to the stock of scientific knowledge in the field of paleontology.

In other words, there are positive externalities associated with recovering some (but not all) fossils. The problem with goods that have positive externalities is that, because the social benefit (what Hallwood and Miceli term the public good value) of recovery exceeds the private benefit (private value), private fossil hunters would engage in too little fossil hunting relative to the socially efficient (welfare maximising) amount of search. So, too few fossils would be discovered. On top of that, commercial collectors have little incentive to care about the scientific value of their finds, and so would not protect them in a way that preserves knowledge.

As a policy-maker, it may be tempting to try and capture the maximum public benefit by mandating that fossils must be given to museums or public academic institutions. However, that approach actually makes the problem of under-discovery worse, because then there is no chance of a private reward for recovery. On the other hand, having no restrictions on what happens to fossils after they are found would lead to more search and more fossils being found and excavated, but an inefficiently small amount of scientific knowledge being generated (because uncareful and low-cost excavation of fossils destroys much of the scientific value, which comes from their careful preservation in context). An example of this that I use in my ECONS102 class is when early palentologists paid Chinese peasants for each fragment of fossil they found. Unsurprisingly, the peasants found large fossils and then broke them up into smaller fragments, in order to earn a greater reward.

The article works through the various incentives mathematically and graphically, then looks at the current state of the law in the U.S., which could do with some improvement. Hallwood and Miceli conclude that:

Our analysis has shown that laws protecting scientific value are warranted based on the public good nature of fossil values, but this factor potentially creates an offsetting disincentive for profit-motivated collectors to engage in search, which is an essential prerequisite to recovery. Thus, if the scientific community needs to rely at least to some extent on private collectors to locate important fossils, there must be some recognition of the incentives that those searchers face. Federal legislation in fact pays little regard to this factor.

Their solution is interesting, but fairly intuitive:

...we believe there are lessons to be learned from the common law and state legislation pertaining to recovery of historic shipwrecks, which present many of the same economic issues.

As they note in one of the footnotes to the paper, in relation to the recovery of shipwrecks:

...the admiralty courts aim to balance the recovery of private (treasure) values and public (scientific archaeological) values from sunken wrecks. Neither is prioritized over the other. Second, property rights to work over sunken wrecks are granted to private companies working on federal (submerged) lands. Third, the admiralty courts promote the collection of sound archaeological knowledge from a historic shipwreck through two devices: (1) there is variation in the percentage of treasure value retained by a salvage company depending on the quality of work performed; and, (2) in cases of poor or nonexistent archeological work, applications for permits in the future can be denied.

So, it seems that, in theory at least, we possibly should treat fossils like shipwrecks, if we want both the optimal amount of search for fossils and the recovery of the optimal amount of scientific knowledge. 

Crying babies and the Coase Theorem

This week in my ECONS102 class, we've been covering externalities. An externality is the uncompensated impact of the actions of one person on the wellbeing of a third party. Externalities can be negative (they make the third party worse off) or positive (they make the third party better off). We call them externalities because they lie outside the decision that created them - that is, some of the costs or benefits are external to the person whose action creates them.

A key part of the topic is understanding the Coase Theorem (named for the late Nobel prize-winner Ronald Coase) - the idea that, if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own (that is, without government intervention). It's an important idea because it is tempting to believe that, whenever there is an externality, it is the government's job to fix it, often through some form of regulation. But the theorem tells us that government intervention isn't always necessary.

The Coase Theorem first requires us to recognise the rights and entitlements associated with an externality. I'll illustrate with the example from this article in the New Zealand Herald last month:

A Sydney mother is "fuming" after receiving an "unbelievable" note about her parenting in her letter box.

The new mum shared a photo of the letter on Facebook, where the next door neighbours complained about her baby crying during the night.

"We would have called you but we are never sure when you are around," the note reads.

"We just wanted to let you know that unfortunately we have had a number of disturbed nights sleep recently due to the thinness of the walls between our units."

The neighbours added while they don't have kids of their own they're sure "it's not at all easy to soothe a crying baby".

"We really would appreciate anything you can do to help us get more sleep, particularly during the early hours," the note reads.

"Thank you for your consideration of this. I am sure we all look forward to more undisturbed nights' sleep."

A crying baby creates a negative externality - they impose a cost on the neighbour, who is losing sleep. How could the two parties negotiate a solution to this problem? It depends on the rights and entitlements.

Both parties have rights here. The neighbour has the right to quiet enjoyment of their home - they shouldn't have to worry about being disturbed at night. The mother has the right to have a baby at home, and babies are known to cry. So, there are competing rights. The bargaining solution will depend on which party has the overriding rights - whose rights are protected more under the law.

Let's work it through from both possible perspectives. First, let's say that the overriding rights belong to the neighbour - their right to quiet enjoyment will be protected. The default solution is that the mother has to quiet the baby in some way (or maybe they have to move somewhere else). The alternative solution is that mother and baby stay, but they agree to pay compensation to the neighbour for the neighbour's loss of sleep. The amount of compensation would have to be at least as much as whatever the neighbour values their sleep at (otherwise they wouldn't agree, and they don't have to, since under the default solution they would get quiet). However, the compensation has to be less than whatever the mother values staying in that home with their baby at (otherwise, mother and baby would be better off moving, rather than paying the compensation).

Now let's look at it the other way. Let's say that the overriding rights belong to the mother - her right to have her baby at that home will be protected. Now, the default solution is that the neighbour has to put up with the crying (or maybe they have to move somewhere else). The alternative solution is that mother and baby move away, but are paid compensation by the neighbour in order to do so. In this case, the amount of compensation would have to be at least as much as whatever the mother values living in that house with her baby at (otherwise they wouldn't agree, and they don't have to, since under the default solution the neighbour just has to put up with the crying). However, the compensation has to be less than whatever the neighbour values their lost sleep at (otherwise, they would be better off moving or putting up with the crying, rather than paying the compensation).

The Coase Theorem tells us how a bargaining solution could arise when there is an externality problem. However, it requires both parties to reach an agreement. In this case, given that the mother is already "fuming" about the neighbour's note, that seems unlikely.