WEBVTT 00:00:00.000 --> 00:00:02.444 align:middle line:90% [SQUEAKING] 00:00:02.444 --> 00:00:04.388 align:middle line:90% [RUSTLING] 00:00:04.388 --> 00:00:05.360 align:middle line:90% [CLICKING] 00:00:05.360 --> 00:00:10.125 align:middle line:90% 00:00:10.125 --> 00:00:12.000 align:middle line:84% JON GRUBER: The course is essentially divided 00:00:12.000 --> 00:00:13.480 align:middle line:90% into three sections. 00:00:13.480 --> 00:00:15.800 align:middle line:84% OK, we've got the first section on externalities 00:00:15.800 --> 00:00:19.240 align:middle line:84% of public goods, sort of the government regulatory approach. 00:00:19.240 --> 00:00:20.800 align:middle line:84% We've got a second section devoted 00:00:20.800 --> 00:00:22.400 align:middle line:84% to social insurance and all the things 00:00:22.400 --> 00:00:24.680 align:middle line:84% the government spends money on to protect us 00:00:24.680 --> 00:00:26.600 align:middle line:84% against various risks in society, 00:00:26.600 --> 00:00:28.960 align:middle line:84% and the third section on taxation. 00:00:28.960 --> 00:00:30.680 align:middle line:84% So today we'll start with chapter 5 00:00:30.680 --> 00:00:33.000 align:middle line:90% and talk about externalities. 00:00:33.000 --> 00:00:35.560 align:middle line:84% Now, we'll go into more detail next time. 00:00:35.560 --> 00:00:38.960 align:middle line:84% But the classic example of what we call an externality 00:00:38.960 --> 00:00:41.700 align:middle line:84% is global warming and climate change. 00:00:41.700 --> 00:00:44.200 align:middle line:84% I don't need to tell you about the horrors of climate change 00:00:44.200 --> 00:00:47.280 align:middle line:84% and what the future looks like under a world 00:00:47.280 --> 00:00:49.820 align:middle line:90% of a rapidly-warming climate. 00:00:49.820 --> 00:00:53.840 align:middle line:84% You can see if you look at figure 5.1 on your handout-- 00:00:53.840 --> 00:00:58.120 align:middle line:84% you can see the rapid rise in global temperatures 00:00:58.120 --> 00:01:01.200 align:middle line:84% that we've seen in recent decades. 00:01:01.200 --> 00:01:03.500 align:middle line:84% It's only spiked massively in the years 00:01:03.500 --> 00:01:05.220 align:middle line:84% since this textbook was published. 00:01:05.220 --> 00:01:07.300 align:middle line:84% There's actually been an upward spike. 00:01:07.300 --> 00:01:08.980 align:middle line:84% As you know, the global temperatures 00:01:08.980 --> 00:01:12.660 align:middle line:84% have risen rapidly over the past century 00:01:12.660 --> 00:01:15.940 align:middle line:84% and will continue to rise rapidly in the near future. 00:01:15.940 --> 00:01:20.860 align:middle line:84% That is unambiguously due to human activity, like driving-- 00:01:20.860 --> 00:01:22.740 align:middle line:84% that basically, the more we drive, 00:01:22.740 --> 00:01:24.420 align:middle line:84% the more carbon we put in the air, 00:01:24.420 --> 00:01:27.140 align:middle line:90% the more the world is warming. 00:01:27.140 --> 00:01:31.220 align:middle line:84% Yet when you last drove, did you think about that? 00:01:31.220 --> 00:01:33.580 align:middle line:84% Did you think when you got behind the wheel of a car, 00:01:33.580 --> 00:01:35.940 align:middle line:84% that you were microscopically but measurably putting 00:01:35.940 --> 00:01:38.660 align:middle line:84% Bangladesh this close to being underwater? 00:01:38.660 --> 00:01:40.060 align:middle line:90% No, you did not. 00:01:40.060 --> 00:01:42.300 align:middle line:84% You did not think about that when you drove your car. 00:01:42.300 --> 00:01:45.820 align:middle line:84% And that's because global warming and emissions 00:01:45.820 --> 00:01:48.180 align:middle line:84% from driving are a classic example of what 00:01:48.180 --> 00:01:50.880 align:middle line:90% we call a negative externality. 00:01:50.880 --> 00:01:54.620 align:middle line:90% 00:01:54.620 --> 00:01:56.840 align:middle line:90% Negative externality. 00:01:56.840 --> 00:02:00.670 align:middle line:90% 00:02:00.670 --> 00:02:06.950 align:middle line:84% A negative externality-- an externality in general 00:02:06.950 --> 00:02:14.350 align:middle line:84% arises whenever the actions of one party impact another party, 00:02:14.350 --> 00:02:16.590 align:middle line:84% and the first party does not bear 00:02:16.590 --> 00:02:19.270 align:middle line:90% the consequences of doing so. 00:02:19.270 --> 00:02:22.710 align:middle line:84% Whenever the actions of one party impact another party, 00:02:22.710 --> 00:02:25.190 align:middle line:84% and that first party does not bear the consequence of doing 00:02:25.190 --> 00:02:27.510 align:middle line:90% so, there is an externality. 00:02:27.510 --> 00:02:30.230 align:middle line:84% You do not bear the consequence of putting Bangladesh 00:02:30.230 --> 00:02:33.550 align:middle line:84% microscopically, but measurably more underwater by driving. 00:02:33.550 --> 00:02:37.710 align:middle line:84% Therefore, there is a negative externality in this case. 00:02:37.710 --> 00:02:39.748 align:middle line:84% So externalities are the classic-- 00:02:39.748 --> 00:02:41.290 align:middle line:84% if you think about the prototypical-- 00:02:41.290 --> 00:02:44.510 align:middle line:84% if think about the term market failure in economics, 00:02:44.510 --> 00:02:47.490 align:middle line:84% the classic example economists turn to are externalities. 00:02:47.490 --> 00:02:50.190 align:middle line:84% This is sort of the most market-failure-y of the market 00:02:50.190 --> 00:02:51.030 align:middle line:90% failures. 00:02:51.030 --> 00:02:53.110 align:middle line:84% And that's why we learn about it first. 00:02:53.110 --> 00:02:56.073 align:middle line:84% So today we're going to talk about externality theory. 00:02:56.073 --> 00:02:57.990 align:middle line:84% It'll bleed over a little in the next lecture. 00:02:57.990 --> 00:02:59.865 align:middle line:84% And then we'll spend the rest of next lecture 00:02:59.865 --> 00:03:02.730 align:middle line:84% and lecture after talking about examples of externalities 00:03:02.730 --> 00:03:06.050 align:middle line:84% in the real world, first in the environmental context 00:03:06.050 --> 00:03:08.090 align:middle line:90% and then in the health context. 00:03:08.090 --> 00:03:13.610 align:middle line:84% So we're going to start with the basic theory of externalities. 00:03:13.610 --> 00:03:17.310 align:middle line:84% Now, in this case, I'm going to do this primarily graphically. 00:03:17.310 --> 00:03:19.690 align:middle line:84% We'll do the mathematics of externalities in section 00:03:19.690 --> 00:03:20.970 align:middle line:90% on Friday. 00:03:20.970 --> 00:03:23.070 align:middle line:84% But basically, your goal in this class, 00:03:23.070 --> 00:03:26.290 align:middle line:84% as I said in 14.01 for those who took it 14.01 with me, 00:03:26.290 --> 00:03:30.250 align:middle line:84% is to understand every topic intuitively, graphically, 00:03:30.250 --> 00:03:31.570 align:middle line:90% and mathematically. 00:03:31.570 --> 00:03:32.810 align:middle line:90% That's our goal here. 00:03:32.810 --> 00:03:35.970 align:middle line:84% I will provide you the intuition and the graphics 00:03:35.970 --> 00:03:38.210 align:middle line:84% here in lecture, sometimes the math. 00:03:38.210 --> 00:03:40.590 align:middle line:84% Where I don't do the math, section will add the math. 00:03:40.590 --> 00:03:42.690 align:middle line:84% But between lecture and section, you 00:03:42.690 --> 00:03:44.250 align:middle line:84% should understand every one of these topics at all three 00:03:44.250 --> 00:03:44.950 align:middle line:90% of those levels. 00:03:44.950 --> 00:03:47.770 align:middle line:84% And it's important that you understand all three of them 00:03:47.770 --> 00:03:49.730 align:middle line:84% to really get the full benefit of this course 00:03:49.730 --> 00:03:51.650 align:middle line:90% and to do well in the class. 00:03:51.650 --> 00:03:55.390 align:middle line:84% So let's talk about four types of externalities. 00:03:55.390 --> 00:03:57.290 align:middle line:90% Let's start by type 1. 00:03:57.290 --> 00:04:01.073 align:middle line:84% Let's talk about negative production externalities. 00:04:01.073 --> 00:04:02.490 align:middle line:84% It's the first type of externality 00:04:02.490 --> 00:04:07.870 align:middle line:84% I want to talk about, negative production externalities. 00:04:07.870 --> 00:04:12.065 align:middle line:84% So basically, let's talk about an example-- 00:04:12.065 --> 00:04:14.190 align:middle line:84% a running example used through this lecture-- which 00:04:14.190 --> 00:04:18.550 align:middle line:84% is the example of a steel plant that produces steel and sits 00:04:18.550 --> 00:04:20.589 align:middle line:90% on a river. 00:04:20.589 --> 00:04:22.630 align:middle line:84% And to make life easy, we're going 00:04:22.630 --> 00:04:28.570 align:middle line:84% to assume that each unit of steel sells for $1. 00:04:28.570 --> 00:04:30.750 align:middle line:84% So the firm revenues and quantities are the same. 00:04:30.750 --> 00:04:33.850 align:middle line:84% This is a trick in economics we call making a numeraire good. 00:04:33.850 --> 00:04:35.630 align:middle line:84% If you make the price of something $1, 00:04:35.630 --> 00:04:38.470 align:middle line:84% then quantities and expenditures are the same. 00:04:38.470 --> 00:04:39.850 align:middle line:90% So a unit of steel costs $1. 00:04:39.850 --> 00:04:41.725 align:middle line:84% So the amount of steel produced is the amount 00:04:41.725 --> 00:04:43.270 align:middle line:90% of money made by the company. 00:04:43.270 --> 00:04:46.150 align:middle line:84% We're also going to assume that for every unit of steel 00:04:46.150 --> 00:04:49.110 align:middle line:84% produced, there is one unit of sludge produced 00:04:49.110 --> 00:04:50.890 align:middle line:90% as a byproduct of that steel. 00:04:50.890 --> 00:04:53.150 align:middle line:84% And that gets dumped into a river. 00:04:53.150 --> 00:04:57.380 align:middle line:84% So mechanically, when you make a unit of steel, 00:04:57.380 --> 00:05:00.200 align:middle line:84% you make a unit of sludge that falls into the river. 00:05:00.200 --> 00:05:02.040 align:middle line:90% That floats down the river. 00:05:02.040 --> 00:05:04.960 align:middle line:84% Downstream from the plant is a set of fishermen. 00:05:04.960 --> 00:05:06.957 align:middle line:84% Those fishermen are catching fish in the river. 00:05:06.957 --> 00:05:08.540 align:middle line:84% But when the sludge floats downstream, 00:05:08.540 --> 00:05:10.400 align:middle line:90% it kills some of their fish. 00:05:10.400 --> 00:05:13.680 align:middle line:84% And the fishermen, as a result, make less money. 00:05:13.680 --> 00:05:16.840 align:middle line:84% This is a classic example of a negative production 00:05:16.840 --> 00:05:19.640 align:middle line:84% externality-- negative because it's having a negative effect 00:05:19.640 --> 00:05:22.880 align:middle line:84% on the fishermen, production because it comes 00:05:22.880 --> 00:05:24.897 align:middle line:84% from the production of steel, and externality 00:05:24.897 --> 00:05:26.980 align:middle line:84% because the steel plant owner doesn't give a shit. 00:05:26.980 --> 00:05:29.320 align:middle line:84% He's just making his steel and some fish are dying. 00:05:29.320 --> 00:05:32.000 align:middle line:84% OK, so how do we think about that graphically? 00:05:32.000 --> 00:05:35.680 align:middle line:84% Well, we think about that in the context of the market for steel. 00:05:35.680 --> 00:05:36.277 align:middle line:90% OK? 00:05:36.277 --> 00:05:37.860 align:middle line:84% So let's imagine the market for steel. 00:05:37.860 --> 00:05:39.527 align:middle line:84% You have some quantity of steel produced 00:05:39.527 --> 00:05:44.440 align:middle line:84% on this axis and the price and the steel up here. 00:05:44.440 --> 00:05:50.220 align:middle line:84% Now, people get a benefit from using steel. 00:05:50.220 --> 00:05:53.460 align:middle line:84% There's some marginal benefit curve-- 00:05:53.460 --> 00:05:56.820 align:middle line:84% marginal benefit, which we also call the demand curve. 00:05:56.820 --> 00:05:59.620 align:middle line:84% Remember when you reviewed in chapter 2, 00:05:59.620 --> 00:06:01.620 align:middle line:84% the demand curve represents the marginal benefit 00:06:01.620 --> 00:06:03.140 align:middle line:90% of using a unit of steel. 00:06:03.140 --> 00:06:07.940 align:middle line:84% And then we have some marginal cost curve, 00:06:07.940 --> 00:06:11.320 align:middle line:84% which is the marginal cost of producing a unit of steel. 00:06:11.320 --> 00:06:13.820 align:middle line:84% And the private equilibrium, as we know, 00:06:13.820 --> 00:06:20.180 align:middle line:84% are where marginal benefits equal marginal costs. 00:06:20.180 --> 00:06:25.760 align:middle line:84% And that will be at a unit of production. 00:06:25.760 --> 00:06:31.900 align:middle line:84% We'll call it Q2 At a price and a unit of production-- 00:06:31.900 --> 00:06:33.435 align:middle line:90% I'm sorry, P1. 00:06:33.435 --> 00:06:34.560 align:middle line:90% There's a typo in the book. 00:06:34.560 --> 00:06:36.560 align:middle line:90% We'll call this P1 and Q1. 00:06:36.560 --> 00:06:39.580 align:middle line:90% 00:06:39.580 --> 00:06:42.620 align:middle line:84% Sometimes when I'm teaching I'll catch typos in the book. 00:06:42.620 --> 00:06:45.420 align:middle line:84% Paul, can you send me an email telling me there's a typo with 00:06:45.420 --> 00:06:48.020 align:middle line:90% figure 5-2? 00:06:48.020 --> 00:06:48.520 align:middle line:90% OK. 00:06:48.520 --> 00:06:51.120 align:middle line:84% Figure 5-2 has Q1 and Q2 mislabeled. 00:06:51.120 --> 00:06:54.980 align:middle line:84% So basically what you see is that's the private equilibrium. 00:06:54.980 --> 00:06:56.240 align:middle line:90% That's 14.01. 00:06:56.240 --> 00:06:58.600 align:middle line:90% Now, what we don't do in 14.01-- 00:06:58.600 --> 00:07:00.440 align:middle line:84% I did in one lecture, but what you generally 00:07:00.440 --> 00:07:02.520 align:middle line:84% don't do in 14.01-- is realize that we've 00:07:02.520 --> 00:07:04.397 align:middle line:84% made an implicit assumption here, 00:07:04.397 --> 00:07:06.480 align:middle line:84% that these are actually not the marginal benefits. 00:07:06.480 --> 00:07:08.520 align:middle line:84% These are the private marginal benefits 00:07:08.520 --> 00:07:11.880 align:middle line:90% and private marginal costs. 00:07:11.880 --> 00:07:15.240 align:middle line:84% But in reality, society may value things differently 00:07:15.240 --> 00:07:17.640 align:middle line:90% than the private producer does. 00:07:17.640 --> 00:07:20.360 align:middle line:84% And in particular, every unit of steel 00:07:20.360 --> 00:07:23.560 align:middle line:84% that's being produced imposes damage on the fishermen, 00:07:23.560 --> 00:07:26.400 align:middle line:84% damage of an amount D. So we're going 00:07:26.400 --> 00:07:30.160 align:middle line:84% to draw a social marginal cost curve, which 00:07:30.160 --> 00:07:35.240 align:middle line:84% is the private marginal cost shifted down by the amount D. 00:07:35.240 --> 00:07:38.360 align:middle line:84% I'm assuming that damage is linear. 00:07:38.360 --> 00:07:40.223 align:middle line:84% It doesn't have to be a parallel shift. 00:07:40.223 --> 00:07:41.640 align:middle line:84% In fact, we'll show examples later 00:07:41.640 --> 00:07:43.480 align:middle line:90% where it's not a parallel shift. 00:07:43.480 --> 00:07:45.860 align:middle line:84% But for now, assume it's a linear amount of damage. 00:07:45.860 --> 00:07:50.770 align:middle line:84% So it's a downward parallel shift of the cost curve. 00:07:50.770 --> 00:07:54.030 align:middle line:84% The social marginal cost is what it actually costs society. 00:07:54.030 --> 00:07:56.390 align:middle line:84% What does it cost society to produce a unit of steel? 00:07:56.390 --> 00:07:57.890 align:middle line:84% Well, it costs the cost of producing 00:07:57.890 --> 00:08:01.970 align:middle line:84% that steel plus society loses by the amount of damage 00:08:01.970 --> 00:08:04.450 align:middle line:90% done to the fish. 00:08:04.450 --> 00:08:07.770 align:middle line:84% So from society's perspective, the optimal level of production 00:08:07.770 --> 00:08:10.770 align:middle line:90% is here. 00:08:10.770 --> 00:08:13.770 align:middle line:84% I'm sorry, I did something wrong. 00:08:13.770 --> 00:08:15.110 align:middle line:90% Yes, that's what I did wrong. 00:08:15.110 --> 00:08:15.790 align:middle line:90% OK, my bad. 00:08:15.790 --> 00:08:17.490 align:middle line:90% I'm sorry. 00:08:17.490 --> 00:08:19.890 align:middle line:90% Let's go back. 00:08:19.890 --> 00:08:20.862 align:middle line:90% Erase that figure. 00:08:20.862 --> 00:08:23.070 align:middle line:84% This is what happens when I try to do my own figures. 00:08:23.070 --> 00:08:23.950 align:middle line:90% I didn't make a typo. 00:08:23.950 --> 00:08:25.570 align:middle line:84% You can get rid of that email, Paul. 00:08:25.570 --> 00:08:26.870 align:middle line:90% I should trust my textbook. 00:08:26.870 --> 00:08:29.010 align:middle line:84% OK, let's do this again, shall we? 00:08:29.010 --> 00:08:32.490 align:middle line:84% We have a demand, which is the private marginal benefit. 00:08:32.490 --> 00:08:35.990 align:middle line:84% We have a supply, which is the private marginal cost. 00:08:35.990 --> 00:08:39.850 align:middle line:84% We have a private market equilibrium at Q1, P1. 00:08:39.850 --> 00:08:44.250 align:middle line:84% Now, I'm sorry, the costs are of course higher 00:08:44.250 --> 00:08:46.610 align:middle line:90% due to the externality. 00:08:46.610 --> 00:08:50.470 align:middle line:84% The amount of damage D makes a social marginal cost 00:08:50.470 --> 00:08:52.635 align:middle line:84% that is higher than the private marginal cost. 00:08:52.635 --> 00:08:54.510 align:middle line:84% I of course should have seen that right away. 00:08:54.510 --> 00:08:55.927 align:middle line:84% The social marginal cost is higher 00:08:55.927 --> 00:08:57.750 align:middle line:90% than the private marginal cost. 00:08:57.750 --> 00:09:00.790 align:middle line:84% Therefore, the optimal social level of production 00:09:00.790 --> 00:09:06.550 align:middle line:84% is Q2, a lower level of production. 00:09:06.550 --> 00:09:08.110 align:middle line:90% Why? 00:09:08.110 --> 00:09:12.070 align:middle line:84% Because private producers here overproduce 00:09:12.070 --> 00:09:13.910 align:middle line:84% because they do not account for the damage 00:09:13.910 --> 00:09:15.710 align:middle line:90% they're doing to society. 00:09:15.710 --> 00:09:19.630 align:middle line:84% They stop at the point where their private costs 00:09:19.630 --> 00:09:22.590 align:middle line:84% equal the private benefits, but they should be stopping sooner. 00:09:22.590 --> 00:09:24.870 align:middle line:84% They should be stopping with the social costs 00:09:24.870 --> 00:09:26.430 align:middle line:90% equal to marginal benefits. 00:09:26.430 --> 00:09:29.830 align:middle line:84% As a result, they are creating a deadweight loss 00:09:29.830 --> 00:09:32.750 align:middle line:90% equal to this area. 00:09:32.750 --> 00:09:36.270 align:middle line:84% That deadweight loss is units that 00:09:36.270 --> 00:09:41.510 align:middle line:84% are produced where the social marginal cost is-- 00:09:41.510 --> 00:09:44.550 align:middle line:84% I'm sorry, where the social marginal cost-- 00:09:44.550 --> 00:09:45.730 align:middle line:90% once again I did this wrong. 00:09:45.730 --> 00:09:46.710 align:middle line:90% I'm sorry. 00:09:46.710 --> 00:09:48.730 align:middle line:84% I got to be looking at my notes more. 00:09:48.730 --> 00:09:51.250 align:middle line:84% This has got a deadweight loss of-- 00:09:51.250 --> 00:09:53.210 align:middle line:90% this is Q2. 00:09:53.210 --> 00:09:54.710 align:middle line:84% OK, got to look at my graph more. 00:09:54.710 --> 00:09:55.730 align:middle line:90% This is Q2. 00:09:55.730 --> 00:09:58.970 align:middle line:84% So it is creating a deadweight loss of this amount. 00:09:58.970 --> 00:10:00.510 align:middle line:90% And how do I know that's wrong? 00:10:00.510 --> 00:10:02.690 align:middle line:84% Because what do deadweight loss triangles do? 00:10:02.690 --> 00:10:05.970 align:middle line:84% Deadweight loss triangles always point 00:10:05.970 --> 00:10:09.750 align:middle line:84% to the optimum and widen outwards from there. 00:10:09.750 --> 00:10:14.130 align:middle line:84% So the deadweight loss here is the triangle 00:10:14.130 --> 00:10:17.410 align:middle line:84% that starts here at the intersection 00:10:17.410 --> 00:10:20.130 align:middle line:84% of social marginal cost and private marginal benefits 00:10:20.130 --> 00:10:25.070 align:middle line:84% and expands outwards to here and ends at the private equilibrium. 00:10:25.070 --> 00:10:27.370 align:middle line:84% And that's the deadweight loss triangle. 00:10:27.370 --> 00:10:29.410 align:middle line:84% Here's the trick with drawing deadweight loss 00:10:29.410 --> 00:10:32.470 align:middle line:84% triangles, why I immediately saw I was doing it wrong. 00:10:32.470 --> 00:10:36.850 align:middle line:84% Remember, deadweight loss infinitely close to the optimum 00:10:36.850 --> 00:10:38.210 align:middle line:90% is zero. 00:10:38.210 --> 00:10:40.915 align:middle line:84% OK, if you deviate from an optimum by epsilon, 00:10:40.915 --> 00:10:43.290 align:middle line:84% it's a tiny deadweight loss, because you're close enough. 00:10:43.290 --> 00:10:45.530 align:middle line:84% The further you move from the optimum, 00:10:45.530 --> 00:10:47.120 align:middle line:84% the worse the deadweight loss is. 00:10:47.120 --> 00:10:49.180 align:middle line:84% And that's an important trick to remember, 00:10:49.180 --> 00:10:50.420 align:middle line:84% that deadweight loss triangle is going 00:10:50.420 --> 00:10:51.680 align:middle line:84% to be smallest right by the optimum, 00:10:51.680 --> 00:10:53.200 align:middle line:84% and they're going to get bigger as you move further away. 00:10:53.200 --> 00:10:53.700 align:middle line:90% Yeah. 00:10:53.700 --> 00:10:55.660 align:middle line:84% AUDIENCE: Would the deadweight loss 00:10:55.660 --> 00:10:58.480 align:middle line:84% be the loss you get because the fish are dying? 00:10:58.480 --> 00:11:00.440 align:middle line:84% JON GRUBER: It's the loss to society. 00:11:00.440 --> 00:11:01.520 align:middle line:90% Let's be very clear. 00:11:01.520 --> 00:11:04.220 align:middle line:84% It's the loss to society because the steel producer 00:11:04.220 --> 00:11:06.908 align:middle line:84% overproduces because he doesn't recognize the fish are dying. 00:11:06.908 --> 00:11:08.700 align:middle line:84% So it's a somewhat more complicated version 00:11:08.700 --> 00:11:09.440 align:middle line:90% of your answer. 00:11:09.440 --> 00:11:11.180 align:middle line:84% You're right in shorthand, but it's 00:11:11.180 --> 00:11:14.180 align:middle line:84% important to understand the full economics here. 00:11:14.180 --> 00:11:16.700 align:middle line:84% The deadweight loss is the loss to society, 00:11:16.700 --> 00:11:21.500 align:middle line:84% because the steel plant does not recognize the damage he's doing, 00:11:21.500 --> 00:11:23.097 align:middle line:84% and therefore overproduces steel. 00:11:23.097 --> 00:11:24.680 align:middle line:84% And that creates this loss to society. 00:11:24.680 --> 00:11:25.860 align:middle line:90% Good question. 00:11:25.860 --> 00:11:26.360 align:middle line:90% OK. 00:11:26.360 --> 00:11:27.160 align:middle line:90% Other questions about that? 00:11:27.160 --> 00:11:28.860 align:middle line:84% I'm sorry about the graph screw-ups, 00:11:28.860 --> 00:11:31.472 align:middle line:90% but other questions about that? 00:11:31.472 --> 00:11:36.100 align:middle line:84% OK, so that is how we think about a negative production 00:11:36.100 --> 00:11:37.220 align:middle line:90% externality. 00:11:37.220 --> 00:11:39.540 align:middle line:84% Because the private actor does not 00:11:39.540 --> 00:11:43.340 align:middle line:84% account for the damage they're doing, they produce too much. 00:11:43.340 --> 00:11:45.040 align:middle line:84% And that creates a deadweight loss 00:11:45.040 --> 00:11:47.248 align:middle line:84% for the reasons that was just expressed in the answer 00:11:47.248 --> 00:11:48.600 align:middle line:90% to this question. 00:11:48.600 --> 00:11:51.880 align:middle line:84% Now, on the other hand, externalities do not always 00:11:51.880 --> 00:11:53.480 align:middle line:90% have to come from production. 00:11:53.480 --> 00:12:00.280 align:middle line:84% We can also have what we call negative consumption 00:12:00.280 --> 00:12:01.420 align:middle line:90% externalities. 00:12:01.420 --> 00:12:05.440 align:middle line:90% 00:12:05.440 --> 00:12:08.480 align:middle line:84% Negative consumption externalities. 00:12:08.480 --> 00:12:12.080 align:middle line:84% So for example, here we want to think about things where 00:12:12.080 --> 00:12:18.120 align:middle line:84% your consumption of the good affects me negatively 00:12:18.120 --> 00:12:19.540 align:middle line:90% and you don't account for it. 00:12:19.540 --> 00:12:22.840 align:middle line:84% The classic example, of course, would be cigarette smoking. 00:12:22.840 --> 00:12:25.213 align:middle line:84% So let's think about the market for cigarettes. 00:12:25.213 --> 00:12:26.880 align:middle line:84% Here we have the quantity for cigarettes 00:12:26.880 --> 00:12:28.440 align:middle line:90% and the price of cigarettes. 00:12:28.440 --> 00:12:31.640 align:middle line:84% We have some private demand for cigarettes, 00:12:31.640 --> 00:12:33.520 align:middle line:90% which is the marginal benefit. 00:12:33.520 --> 00:12:36.600 align:middle line:84% That's how much people value the next cigarette. 00:12:36.600 --> 00:12:39.480 align:middle line:84% There's some cost of producing cigarettes, 00:12:39.480 --> 00:12:41.540 align:middle line:84% which is the private marginal cost, 00:12:41.540 --> 00:12:43.980 align:middle line:90% the private marginal benefit. 00:12:43.980 --> 00:12:47.980 align:middle line:84% And there's some private market equilibrium with Q1 cigarettes 00:12:47.980 --> 00:12:51.300 align:middle line:90% being smoked at a price P1. 00:12:51.300 --> 00:12:57.540 align:middle line:84% So that is the private market equilibrium. 00:12:57.540 --> 00:13:04.020 align:middle line:84% Now, when you smoke a cigarette, what you do 00:13:04.020 --> 00:13:06.293 align:middle line:90% is you impose damage on me. 00:13:06.293 --> 00:13:07.960 align:middle line:84% We'll talk about this more in chapter 6. 00:13:07.960 --> 00:13:10.180 align:middle line:84% You pose damage on me by making me cough. 00:13:10.180 --> 00:13:12.740 align:middle line:84% You pose damage on me by raising my medical bills. 00:13:12.740 --> 00:13:14.740 align:middle line:84% There's a lot of negative external effects 00:13:14.740 --> 00:13:16.820 align:middle line:90% you impose on me by smoking. 00:13:16.820 --> 00:13:21.660 align:middle line:84% What that means is that the social marginal benefit 00:13:21.660 --> 00:13:25.220 align:middle line:84% of the next cigarette is lower than the private marginal 00:13:25.220 --> 00:13:26.100 align:middle line:90% benefit. 00:13:26.100 --> 00:13:31.220 align:middle line:84% So in other words, what happens is the social marginal benefit 00:13:31.220 --> 00:13:32.120 align:middle line:90% is here. 00:13:32.120 --> 00:13:33.965 align:middle line:84% The social marginal benefit is lower 00:13:33.965 --> 00:13:35.340 align:middle line:84% than the private marginal benefit 00:13:35.340 --> 00:13:39.780 align:middle line:84% by the damage you do to me by smoking. 00:13:39.780 --> 00:13:44.350 align:middle line:84% You smoke, so you impose costs on me 00:13:44.350 --> 00:13:45.870 align:middle line:90% that you don't account for. 00:13:45.870 --> 00:13:47.953 align:middle line:84% Now, this has nothing to do with production. 00:13:47.953 --> 00:13:49.870 align:middle line:84% There could be externalities in how we produce 00:13:49.870 --> 00:13:50.930 align:middle line:90% tobacco for tobacco leaf. 00:13:50.930 --> 00:13:52.513 align:middle line:90% But I'm not talking about that. 00:13:52.513 --> 00:13:54.430 align:middle line:84% This is just what arises from your consumption 00:13:54.430 --> 00:13:57.110 align:middle line:84% of the cigarette, so it's on the benefit side. 00:13:57.110 --> 00:13:58.670 align:middle line:84% So by consuming those cigarettes, 00:13:58.670 --> 00:14:02.107 align:middle line:84% you have a social marginal benefit that's lower. 00:14:02.107 --> 00:14:04.690 align:middle line:84% The social benefit is lower than the private marginal benefit. 00:14:04.690 --> 00:14:08.590 align:middle line:84% So once again, the optimal amount of cigarettes is lower. 00:14:08.590 --> 00:14:10.710 align:middle line:84% And once again, we have a deadweight loss. 00:14:10.710 --> 00:14:12.890 align:middle line:84% This time, the deadweight loss is this area. 00:14:12.890 --> 00:14:15.870 align:middle line:90% 00:14:15.870 --> 00:14:20.343 align:middle line:84% We have a deadweight loss because you in your decision 00:14:20.343 --> 00:14:22.510 align:middle line:84% to smoke a cigarette are not accounting for the fact 00:14:22.510 --> 00:14:24.230 align:middle line:90% that it's costly to me. 00:14:24.230 --> 00:14:26.990 align:middle line:90% So you overconsume-- cigarettes. 00:14:26.990 --> 00:14:28.993 align:middle line:84% So just like the steel plant overproduces steel 00:14:28.993 --> 00:14:30.910 align:middle line:84% because it doesn't account for the damage done 00:14:30.910 --> 00:14:35.550 align:middle line:84% to the fishermen, the smoker overconsumes cigarettes 00:14:35.550 --> 00:14:38.070 align:middle line:84% because they don't account for the damage they're doing 00:14:38.070 --> 00:14:41.110 align:middle line:90% to the people from smoking. 00:14:41.110 --> 00:14:41.610 align:middle line:90% OK? 00:14:41.610 --> 00:14:42.610 align:middle line:90% Yeah. 00:14:42.610 --> 00:14:47.655 align:middle line:84% AUDIENCE: Why is it that deadweight loss [INAUDIBLE]? 00:14:47.655 --> 00:14:51.290 align:middle line:84% JON GRUBER: Did I get it wrong again? 00:14:51.290 --> 00:14:53.600 align:middle line:84% It's where private marginal benefits-- 00:14:53.600 --> 00:14:54.350 align:middle line:90% yep, you're right. 00:14:54.350 --> 00:14:54.850 align:middle line:90% Absolutely. 00:14:54.850 --> 00:14:57.730 align:middle line:90% Got that wrong again. 00:14:57.730 --> 00:14:59.130 align:middle line:90% Got that wrong and you're right. 00:14:59.130 --> 00:15:00.690 align:middle line:90% It's here. 00:15:00.690 --> 00:15:05.278 align:middle line:84% It's pointing to the new optimum, which is here. 00:15:05.278 --> 00:15:07.070 align:middle line:84% Pointing to the new optimum, which is here. 00:15:07.070 --> 00:15:07.612 align:middle line:90% You're right. 00:15:07.612 --> 00:15:08.228 align:middle line:90% Good catch. 00:15:08.228 --> 00:15:10.270 align:middle line:84% See, I'm just tricking you all, quizzing you all. 00:15:10.270 --> 00:15:11.650 align:middle line:90% Good job. 00:15:11.650 --> 00:15:12.610 align:middle line:90% OK? 00:15:12.610 --> 00:15:14.390 align:middle line:84% So once again, how do we know it's there? 00:15:14.390 --> 00:15:17.290 align:middle line:84% Because once again, it points to the new optimum. 00:15:17.290 --> 00:15:18.770 align:middle line:84% Points to the new optimum and it's 00:15:18.770 --> 00:15:21.290 align:middle line:84% the gap between where the cost curve is above the benefit 00:15:21.290 --> 00:15:22.850 align:middle line:90% curve. 00:15:22.850 --> 00:15:23.430 align:middle line:90% OK? 00:15:23.430 --> 00:15:26.770 align:middle line:90% Other questions about that? 00:15:26.770 --> 00:15:28.570 align:middle line:90% OK, Yeah. 00:15:28.570 --> 00:15:30.590 align:middle line:84% AUDIENCE: Would you also want a new price? 00:15:30.590 --> 00:15:32.870 align:middle line:84% So would you want to lower the price? 00:15:32.870 --> 00:15:33.730 align:middle line:90% [INAUDIBLE] 00:15:33.730 --> 00:15:36.248 align:middle line:90% 00:15:36.248 --> 00:15:37.790 align:middle line:84% JON GRUBER: No, there's no new price. 00:15:37.790 --> 00:15:39.340 align:middle line:90% There's no market here. 00:15:39.340 --> 00:15:40.090 align:middle line:90% There's no market. 00:15:40.090 --> 00:15:43.350 align:middle line:90% This is an imaginary curve. 00:15:43.350 --> 00:15:45.110 align:middle line:90% Nobody sees this. 00:15:45.110 --> 00:15:47.010 align:middle line:90% So there's no new market here. 00:15:47.010 --> 00:15:48.770 align:middle line:90% There's no new price arising. 00:15:48.770 --> 00:15:49.270 align:middle line:90% OK? 00:15:49.270 --> 00:15:50.645 align:middle line:84% I'm going to come in a little bit 00:15:50.645 --> 00:15:53.650 align:middle line:84% to how a market can lead rise to that price. 00:15:53.650 --> 00:15:56.310 align:middle line:84% But for now, there's no new price. 00:15:56.310 --> 00:16:01.470 align:middle line:84% So there's just the deadweight loss arising. 00:16:01.470 --> 00:16:05.750 align:middle line:84% AUDIENCE: So wouldn't this, I guess, suggest as a consumer 00:16:05.750 --> 00:16:08.065 align:middle line:84% that I should actually be paying less for cigarettes? 00:16:08.065 --> 00:16:10.690 align:middle line:84% JON GRUBER: No, once again, this has nothing to do with prices. 00:16:10.690 --> 00:16:14.070 align:middle line:84% This is just saying that you are imposing-- 00:16:14.070 --> 00:16:18.470 align:middle line:84% basically, your social marginal benefit, you're 00:16:18.470 --> 00:16:19.607 align:middle line:90% imposing a cost on others. 00:16:19.607 --> 00:16:21.190 align:middle line:84% The only reason you think you pay less 00:16:21.190 --> 00:16:22.650 align:middle line:84% is because you're looking at this intersection. 00:16:22.650 --> 00:16:24.530 align:middle line:84% But that intersection is irrelevant for prices. 00:16:24.530 --> 00:16:25.490 align:middle line:90% It's only for quantities. 00:16:25.490 --> 00:16:28.190 align:middle line:84% This isn't a market transaction, so don't worry about affecting 00:16:28.190 --> 00:16:29.850 align:middle line:90% prices, just quantities. 00:16:29.850 --> 00:16:30.350 align:middle line:90% Yeah. 00:16:30.350 --> 00:16:32.630 align:middle line:84% AUDIENCE: Can a deadweight loss be quantified 00:16:32.630 --> 00:16:37.480 align:middle line:84% to the part that's to the firm as well as the one 00:16:37.480 --> 00:16:38.720 align:middle line:90% to the consumers? 00:16:38.720 --> 00:16:41.900 align:middle line:84% JON GRUBER: Well, once again, this is a great question. 00:16:41.900 --> 00:16:43.960 align:middle line:84% There's no deadweight loss to the firm 00:16:43.960 --> 00:16:46.340 align:middle line:84% here because there's nothing in production. 00:16:46.340 --> 00:16:49.140 align:middle line:84% Now, there may be production externalities from tobacco leaf, 00:16:49.140 --> 00:16:51.480 align:middle line:90% but I'm ignoring them now. 00:16:51.480 --> 00:16:52.880 align:middle line:84% I'm just talking about the damage 00:16:52.880 --> 00:16:54.260 align:middle line:90% that you are doing by smoking. 00:16:54.260 --> 00:16:55.540 align:middle line:90% Cigarettes appear magically. 00:16:55.540 --> 00:16:57.320 align:middle line:90% The production is efficient. 00:16:57.320 --> 00:16:58.920 align:middle line:84% But by using them, you are creating 00:16:58.920 --> 00:17:00.480 align:middle line:90% a deadweight loss for society. 00:17:00.480 --> 00:17:01.160 align:middle line:90% Yeah. 00:17:01.160 --> 00:17:04.040 align:middle line:84% AUDIENCE: How do you draw the D and the arrow on this graph? 00:17:04.040 --> 00:17:06.260 align:middle line:84% JON GRUBER: Well basically, this is the damage. 00:17:06.260 --> 00:17:09.400 align:middle line:84% So basically, this D-- sorry, I covered it up here. 00:17:09.400 --> 00:17:14.440 align:middle line:84% This D is the damage that I do to you by smoking. 00:17:14.440 --> 00:17:18.960 align:middle line:84% So it's just like this D is the value of lost fish. 00:17:18.960 --> 00:17:20.859 align:middle line:84% This D is the value of lost health, 00:17:20.859 --> 00:17:22.440 align:middle line:84% say, to you from secondhand smoke 00:17:22.440 --> 00:17:24.079 align:middle line:84% or the value of your higher tax bills 00:17:24.079 --> 00:17:25.970 align:middle line:84% because you pay for more health care. 00:17:25.970 --> 00:17:27.720 align:middle line:84% AUDIENCE: Is it correct to interpret the D 00:17:27.720 --> 00:17:30.920 align:middle line:84% on the left like that is the price of the fish that are now 00:17:30.920 --> 00:17:32.160 align:middle line:90% gone? 00:17:32.160 --> 00:17:33.840 align:middle line:90% And then if so-- 00:17:33.840 --> 00:17:36.820 align:middle line:84% JON GRUBER: This is the value of the fish that are now dead. 00:17:36.820 --> 00:17:38.740 align:middle line:84% This is the value of the lungs that are now 00:17:38.740 --> 00:17:41.700 align:middle line:84% hurt because you're coughing from secondhand smoke, 00:17:41.700 --> 00:17:44.500 align:middle line:90% is another way to think of it. 00:17:44.500 --> 00:17:45.180 align:middle line:90% Yeah. 00:17:45.180 --> 00:17:47.513 align:middle line:84% AUDIENCE: Why doesn't the damage-- or maybe this is just 00:17:47.513 --> 00:17:48.080 align:middle line:90% [INAUDIBLE]. 00:17:48.080 --> 00:17:50.660 align:middle line:84% Why doesn't the damage depend on the marginal benefit? 00:17:50.660 --> 00:17:52.915 align:middle line:84% JON GRUBER: I just said we're assuming it's linear. 00:17:52.915 --> 00:17:54.040 align:middle line:90% We're assuming it's linear. 00:17:54.040 --> 00:17:55.900 align:middle line:84% More generally a little bit later, we'll talk about a case 00:17:55.900 --> 00:17:56.880 align:middle line:90% where it's not linear. 00:17:56.880 --> 00:17:58.820 align:middle line:84% Right now, we're assuming it's linear. 00:17:58.820 --> 00:17:59.600 align:middle line:90% Great questions. 00:17:59.600 --> 00:18:00.100 align:middle line:90% Yeah. 00:18:00.100 --> 00:18:03.060 align:middle line:84% AUDIENCE: So in both cases, the deadweight loss 00:18:03.060 --> 00:18:05.157 align:middle line:84% is below the social marginal cost 00:18:05.157 --> 00:18:06.740 align:middle line:84% and above the social marginal benefit. 00:18:06.740 --> 00:18:11.460 align:middle line:84% JON GRUBER: Basically, it's the gap between the private-- the 00:18:11.460 --> 00:18:13.460 align:middle line:84% it's the gap between the private marginal cost 00:18:13.460 --> 00:18:14.600 align:middle line:90% and the social marginal benefit. 00:18:14.600 --> 00:18:17.183 align:middle line:84% Or in this case, it's the gap between the social marginal cost 00:18:17.183 --> 00:18:18.640 align:middle line:84% and the private marginal benefit. 00:18:18.640 --> 00:18:22.020 align:middle line:84% The bottom line is there's no rule, except that you're 00:18:22.020 --> 00:18:23.700 align:middle line:84% going to have the deadweight loss that's 00:18:23.700 --> 00:18:26.380 align:middle line:84% going to radiate outwards from the social optimum 00:18:26.380 --> 00:18:29.380 align:middle line:84% and end at the private equilibrium. 00:18:29.380 --> 00:18:32.100 align:middle line:84% Because we're going to see an opposite case in a minute. 00:18:32.100 --> 00:18:33.120 align:middle line:90% OK? 00:18:33.120 --> 00:18:33.800 align:middle line:90% Other questions? 00:18:33.800 --> 00:18:34.360 align:middle line:90% Great questions. 00:18:34.360 --> 00:18:35.610 align:middle line:90% I'm glad you guys are engaged. 00:18:35.610 --> 00:18:37.597 align:middle line:84% OK, maybe I need to make more mistakes, 00:18:37.597 --> 00:18:39.930 align:middle line:84% because this gets people-- you guys are way more engaged 00:18:39.930 --> 00:18:41.097 align:middle line:90% than folks usually are here. 00:18:41.097 --> 00:18:42.640 align:middle line:90% Maybe it's just a great class. 00:18:42.640 --> 00:18:43.260 align:middle line:90% I love it. 00:18:43.260 --> 00:18:48.440 align:middle line:84% OK, now, externalities do not have to be negative. 00:18:48.440 --> 00:18:49.760 align:middle line:90% They can be positive. 00:18:49.760 --> 00:18:56.760 align:middle line:84% Let's talk about a positive production externality. 00:18:56.760 --> 00:19:00.200 align:middle line:84% And an example of positive production externality, 00:19:00.200 --> 00:19:03.720 align:middle line:84% remember, is when I produce something 00:19:03.720 --> 00:19:06.400 align:middle line:84% that gives positive benefits to you, 00:19:06.400 --> 00:19:08.840 align:middle line:90% but I don't get those benefits. 00:19:08.840 --> 00:19:12.760 align:middle line:84% And the classic example of that is research and development. 00:19:12.760 --> 00:19:17.880 align:middle line:84% When firms do R&D, the lessons they learn spill over 00:19:17.880 --> 00:19:21.953 align:middle line:84% to other firms that can draw on that R&D. OK, 00:19:21.953 --> 00:19:23.620 align:middle line:84% maybe not at first while it's secretive, 00:19:23.620 --> 00:19:27.440 align:middle line:84% but eventually when it becomes public knowledge. 00:19:27.440 --> 00:19:30.640 align:middle line:84% But the first firm doesn't benefit from that. 00:19:30.640 --> 00:19:32.480 align:middle line:90% So here I have a firm. 00:19:32.480 --> 00:19:34.790 align:middle line:84% I have a firm that's making whatever it is, widgets. 00:19:34.790 --> 00:19:35.790 align:middle line:90% OK, here's the quantity. 00:19:35.790 --> 00:19:37.210 align:middle line:90% Here's the price. 00:19:37.210 --> 00:19:39.230 align:middle line:84% There is some demand for widgets. 00:19:39.230 --> 00:19:41.130 align:middle line:84% That's the private marginal benefit. 00:19:41.130 --> 00:19:42.875 align:middle line:84% There are some supply of widgets. 00:19:42.875 --> 00:19:44.250 align:middle line:84% That's the private marginal cost. 00:19:44.250 --> 00:19:47.990 align:middle line:84% And then some private amount Q1 P1 of widgets. 00:19:47.990 --> 00:19:51.470 align:middle line:90% 00:19:51.470 --> 00:19:55.050 align:middle line:90% Now, when I produce a widget-- 00:19:55.050 --> 00:19:56.210 align:middle line:90% when I produce a widget-- 00:19:56.210 --> 00:19:56.790 align:middle line:90% I'm sorry. 00:19:56.790 --> 00:19:58.130 align:middle line:90% This is not production widgets. 00:19:58.130 --> 00:20:01.110 align:middle line:84% This is production of R&D. This is the market for R&D. 00:20:01.110 --> 00:20:03.530 align:middle line:84% So this is the quantity of R&D in widgets. 00:20:03.530 --> 00:20:05.192 align:middle line:84% This is the price of R&D in widgets. 00:20:05.192 --> 00:20:07.650 align:middle line:84% The price of R&D, you can think of the cost of a scientist. 00:20:07.650 --> 00:20:12.130 align:middle line:84% So it's the quantity of R&D and the price of R&D. Now, 00:20:12.130 --> 00:20:16.552 align:middle line:84% the firm privately decides the optimum amount of R&D to do Q1. 00:20:16.552 --> 00:20:19.010 align:middle line:84% Basically it weighs how much it benefits versus how much it 00:20:19.010 --> 00:20:21.250 align:middle line:90% costs to hire a scientist. 00:20:21.250 --> 00:20:27.130 align:middle line:84% What it misses is when it does R&D, it helps other firms. 00:20:27.130 --> 00:20:35.830 align:middle line:84% And in particular, the social marginal cost of R&D 00:20:35.830 --> 00:20:41.250 align:middle line:84% is actually lower by an amount B than as a private marginal cost. 00:20:41.250 --> 00:20:42.330 align:middle line:90% Why is it lower? 00:20:42.330 --> 00:20:47.070 align:middle line:84% Because when I do it, I'm also helping other firms. 00:20:47.070 --> 00:20:48.750 align:middle line:90% So the total cost to society-- 00:20:48.750 --> 00:20:51.078 align:middle line:84% I think of what does it cost me to hire a scientist? 00:20:51.078 --> 00:20:53.370 align:middle line:84% I don't think, but by the way, when I hire a scientist, 00:20:53.370 --> 00:20:55.620 align:middle line:84% I'm helping a bunch of other firms too, down the road. 00:20:55.620 --> 00:20:56.910 align:middle line:90% I don't think about that. 00:20:56.910 --> 00:20:59.350 align:middle line:84% So effectively, the social marginal cost 00:20:59.350 --> 00:21:00.950 align:middle line:84% is lower in the private marginal cost. 00:21:00.950 --> 00:21:02.450 align:middle line:84% AUDIENCE: Why would you think of that in terms of cost 00:21:02.450 --> 00:21:03.110 align:middle line:90% and not in terms of-- 00:21:03.110 --> 00:21:04.090 align:middle line:84% JON GRUBER: Great, great question. 00:21:04.090 --> 00:21:05.507 align:middle line:84% This question I do get every year. 00:21:05.507 --> 00:21:06.510 align:middle line:90% It's a hard question. 00:21:06.510 --> 00:21:10.190 align:middle line:84% Because this is the consumption side of the market. 00:21:10.190 --> 00:21:12.270 align:middle line:84% This is the production side of the market. 00:21:12.270 --> 00:21:14.970 align:middle line:84% Costs and benefits are confusing. 00:21:14.970 --> 00:21:16.830 align:middle line:84% But think of this as the consumption 00:21:16.830 --> 00:21:20.407 align:middle line:84% side of the market, which is how much R&D you're consuming. 00:21:20.407 --> 00:21:21.990 align:middle line:84% This is how much R&D you're producing. 00:21:21.990 --> 00:21:23.927 align:middle line:84% And you're not producing enough R&D. Now, 00:21:23.927 --> 00:21:25.510 align:middle line:84% it's harder, because the firm consumes 00:21:25.510 --> 00:21:27.290 align:middle line:90% and produces the R&D together. 00:21:27.290 --> 00:21:28.670 align:middle line:90% It's a joint decision. 00:21:28.670 --> 00:21:30.150 align:middle line:84% So it's really just in this sense, 00:21:30.150 --> 00:21:32.233 align:middle line:84% you got to lean more on the technical thing, which 00:21:32.233 --> 00:21:34.520 align:middle line:84% is basically it's through the production of R&D 00:21:34.520 --> 00:21:36.480 align:middle line:90% that this externality happens. 00:21:36.480 --> 00:21:41.377 align:middle line:84% As a result, the social optimum of R&D is higher. 00:21:41.377 --> 00:21:43.960 align:middle line:84% Let's come to your question of which curve is lower or higher. 00:21:43.960 --> 00:21:48.480 align:middle line:84% In this case, the socially optimal level is higher. 00:21:48.480 --> 00:21:54.360 align:middle line:84% And as a result, where the marginal cost is above-- 00:21:54.360 --> 00:21:57.360 align:middle line:84% where the social marginal cost is 00:21:57.360 --> 00:21:59.260 align:middle line:84% below the private marginal benefit, 00:21:59.260 --> 00:22:01.640 align:middle line:90% we get this deadweight loss. 00:22:01.640 --> 00:22:06.040 align:middle line:84% We get this deadweight loss because in these units, 00:22:06.040 --> 00:22:12.280 align:middle line:84% the private marginal benefit is above the social marginal cost. 00:22:12.280 --> 00:22:14.480 align:middle line:84% So firms should be doing that R&D. But they 00:22:14.480 --> 00:22:17.480 align:middle line:84% don't because the private marginal benefit is not higher 00:22:17.480 --> 00:22:19.100 align:middle line:90% than the private marginal cost. 00:22:19.100 --> 00:22:21.640 align:middle line:84% So you take a unit like here, OK? 00:22:21.640 --> 00:22:23.040 align:middle line:90% You take a unit there. 00:22:23.040 --> 00:22:24.260 align:middle line:90% The firm says, wait a second. 00:22:24.260 --> 00:22:26.868 align:middle line:84% At that unit, my private marginal cost 00:22:26.868 --> 00:22:28.660 align:middle line:84% is higher than my private marginal benefit. 00:22:28.660 --> 00:22:30.500 align:middle line:90% I'm not going to do R&D. 00:22:30.500 --> 00:22:34.100 align:middle line:84% But what it should say is, my private marginal benefit is 00:22:34.100 --> 00:22:36.580 align:middle line:84% above the social marginal cost, so I should do R&D. 00:22:36.580 --> 00:22:39.700 align:middle line:84% So it's not doing R&D it should do, creating a deadweight loss 00:22:39.700 --> 00:22:43.900 align:middle line:90% from too little R&D. OK? 00:22:43.900 --> 00:22:46.560 align:middle line:90% Questions about that? 00:22:46.560 --> 00:22:47.060 align:middle line:90% See? 00:22:47.060 --> 00:22:48.500 align:middle line:90% This fits my-- 00:22:48.500 --> 00:22:49.960 align:middle line:90% I do empirical modeling. 00:22:49.960 --> 00:22:52.460 align:middle line:84% See, I made mistakes, you guys asked a bunch of questions. 00:22:52.460 --> 00:22:54.160 align:middle line:84% I didn't, mistake you didn't ask questions. 00:22:54.160 --> 00:22:56.118 align:middle line:84% So my theory that my mistakes lead to questions 00:22:56.118 --> 00:22:57.540 align:middle line:90% is proved empirically. 00:22:57.540 --> 00:22:59.200 align:middle line:84% By the way, that's macroeconomics. 00:22:59.200 --> 00:23:02.433 align:middle line:90% 00:23:02.433 --> 00:23:03.600 align:middle line:90% Sorry, for my macro friends. 00:23:03.600 --> 00:23:04.000 align:middle line:90% All right. 00:23:04.000 --> 00:23:04.780 align:middle line:90% Oh wait, question. 00:23:04.780 --> 00:23:05.280 align:middle line:90% Go ahead. 00:23:05.280 --> 00:23:09.085 align:middle line:90% 00:23:09.085 --> 00:23:10.460 align:middle line:84% AUDIENCE: I have an understanding 00:23:10.460 --> 00:23:13.015 align:middle line:84% that when we're talking about whether it's 00:23:13.015 --> 00:23:15.140 align:middle line:84% positive or negative production externalities, when 00:23:15.140 --> 00:23:18.020 align:middle line:84% we have a production externality we're moving the supply curve. 00:23:18.020 --> 00:23:21.198 align:middle line:84% It seems like when we have a consumption externality, 00:23:21.198 --> 00:23:22.240 align:middle line:90% we move the demand curve. 00:23:22.240 --> 00:23:25.300 align:middle line:84% I can see that, but it doesn't entirely 00:23:25.300 --> 00:23:26.803 align:middle line:90% make sense to me why that is. 00:23:26.803 --> 00:23:28.720 align:middle line:84% JON GRUBER: Well, basically because production 00:23:28.720 --> 00:23:31.460 align:middle line:84% is about supply and consumption is about demand. 00:23:31.460 --> 00:23:34.035 align:middle line:90% 00:23:34.035 --> 00:23:36.160 align:middle line:84% And you're right, it's confusing in cases like this 00:23:36.160 --> 00:23:37.910 align:middle line:84% because we think about the benefit of R&D, 00:23:37.910 --> 00:23:39.360 align:middle line:90% yet we're moving the cost curve. 00:23:39.360 --> 00:23:42.000 align:middle line:84% But once again, it's about something you produce, 00:23:42.000 --> 00:23:45.000 align:middle line:84% so it's going to be a production externality. 00:23:45.000 --> 00:23:47.768 align:middle line:84% Now, let's come to a final example, 00:23:47.768 --> 00:23:49.060 align:middle line:90% which you can guess what it is. 00:23:49.060 --> 00:23:53.000 align:middle line:84% It's a positive consumption externality. 00:23:53.000 --> 00:23:55.760 align:middle line:84% And here, let's not do a graph, because I won't always 00:23:55.760 --> 00:23:56.260 align:middle line:90% do graphs. 00:23:56.260 --> 00:23:57.940 align:middle line:84% Sometimes I'll do math and examples. 00:23:57.940 --> 00:23:59.360 align:middle line:90% Let's do an example here. 00:23:59.360 --> 00:24:00.240 align:middle line:90% OK? 00:24:00.240 --> 00:24:01.840 align:middle line:90% I have a neighbor. 00:24:01.840 --> 00:24:03.200 align:middle line:90% Actually, he moved away. 00:24:03.200 --> 00:24:08.623 align:middle line:84% But I had a neighbor I was not particularly fond of. 00:24:08.623 --> 00:24:10.040 align:middle line:84% I might have, in previous classes, 00:24:10.040 --> 00:24:11.332 align:middle line:90% called him my asshole neighbor. 00:24:11.332 --> 00:24:14.873 align:middle line:84% But he's moved away, so let's not speak badly of him now. 00:24:14.873 --> 00:24:17.040 align:middle line:84% I had a neighbor who I was not particularly fond of. 00:24:17.040 --> 00:24:20.720 align:middle line:84% That neighbor had a habit of getting about halfway 00:24:20.720 --> 00:24:23.160 align:middle line:84% through projects and then stopping. 00:24:23.160 --> 00:24:26.080 align:middle line:84% And in particular, probably 20 years ago, 00:24:26.080 --> 00:24:28.710 align:middle line:84% he got halfway through a major landscape renovation, 00:24:28.710 --> 00:24:29.552 align:middle line:90% then stopped. 00:24:29.552 --> 00:24:32.010 align:middle line:84% And he stopped at the point where there was a gigantic dirt 00:24:32.010 --> 00:24:34.970 align:middle line:84% pile directly outside our kitchen window, 00:24:34.970 --> 00:24:38.050 align:middle line:84% which he then left there for 20 years. 00:24:38.050 --> 00:24:40.550 align:middle line:90% Now, this was not great for us. 00:24:40.550 --> 00:24:41.990 align:middle line:90% But imagine his thinking. 00:24:41.990 --> 00:24:46.570 align:middle line:84% Imagine that to remove that dirt pile would have cost $1,000. 00:24:46.570 --> 00:24:52.210 align:middle line:84% So that's the private marginal cost of removing the dirt pile. 00:24:52.210 --> 00:24:55.790 align:middle line:84% Now, since it was actually an awkward angle for his house, 00:24:55.790 --> 00:24:57.330 align:middle line:90% he couldn't see it very well. 00:24:57.330 --> 00:25:01.850 align:middle line:84% to him, the benefit of reducing that dirt pile was only $600. 00:25:01.850 --> 00:25:04.830 align:middle line:84% So the private marginal benefit was only $600. 00:25:04.830 --> 00:25:06.330 align:middle line:84% So he evaluated it and said, I'm not 00:25:06.330 --> 00:25:07.150 align:middle line:90% going to remove the dirt pile. 00:25:07.150 --> 00:25:08.870 align:middle line:84% It's a shame I didn't finish my project, but what do I care? 00:25:08.870 --> 00:25:10.250 align:middle line:90% I'm not going to pay the grand. 00:25:10.250 --> 00:25:12.170 align:middle line:90% That's a net loss to me. 00:25:12.170 --> 00:25:17.810 align:middle line:84% What he missed was that there's also a $500 benefit to me, which 00:25:17.810 --> 00:25:19.090 align:middle line:90% is the additional benefit. 00:25:19.090 --> 00:25:21.690 align:middle line:90% 00:25:21.690 --> 00:25:31.230 align:middle line:84% So that the total social marginal benefit equals $1,100. 00:25:31.230 --> 00:25:34.310 align:middle line:84% So in fact, it would be socially efficient to remove the dirt 00:25:34.310 --> 00:25:36.470 align:middle line:90% pile. 00:25:36.470 --> 00:25:39.130 align:middle line:84% But he doesn't, because it wasn't privately efficient. 00:25:39.130 --> 00:25:41.230 align:middle line:84% Therefore, you get under-consumption 00:25:41.230 --> 00:25:44.310 align:middle line:90% of dirt pile removal services. 00:25:44.310 --> 00:25:46.510 align:middle line:84% Under-consumption of dirt pile removal 00:25:46.510 --> 00:25:50.910 align:middle line:84% because he's not accounting for the social benefits of doing so. 00:25:50.910 --> 00:25:54.990 align:middle line:84% So I realized the graphs were tricky, even for me. 00:25:54.990 --> 00:25:56.910 align:middle line:90% The main thing is the intuition. 00:25:56.910 --> 00:25:59.077 align:middle line:84% If you got the intuition, everything else will come. 00:25:59.077 --> 00:26:00.493 align:middle line:84% The main thing is intuition, which 00:26:00.493 --> 00:26:02.150 align:middle line:84% is a negative externality is going 00:26:02.150 --> 00:26:05.550 align:middle line:84% to lead to too much of something and therefore deadweight loss 00:26:05.550 --> 00:26:07.165 align:middle line:90% from too much production. 00:26:07.165 --> 00:26:08.790 align:middle line:84% A positive externality is going to lead 00:26:08.790 --> 00:26:11.110 align:middle line:84% to too little of something, and therefore 00:26:11.110 --> 00:26:16.110 align:middle line:84% deadweight loss from too little goods being in the market. 00:26:16.110 --> 00:26:16.762 align:middle line:90% Yeah. 00:26:16.762 --> 00:26:19.470 align:middle line:84% AUDIENCE: I was wondering if you could clarify why number four is 00:26:19.470 --> 00:26:23.328 align:middle line:84% a positive externality if you aren't receiving the extra-- 00:26:23.328 --> 00:26:24.870 align:middle line:84% JON GRUBER: Oh, that's a great point. 00:26:24.870 --> 00:26:27.010 align:middle line:90% But what am I receiving? 00:26:27.010 --> 00:26:28.490 align:middle line:90% A better view. 00:26:28.490 --> 00:26:31.470 align:middle line:84% So it's worth-- the point is I'm not getting the $500. 00:26:31.470 --> 00:26:33.810 align:middle line:90% Great question, actually. 00:26:33.810 --> 00:26:37.170 align:middle line:84% Remember when we learn about welfare in 14.01. 00:26:37.170 --> 00:26:40.090 align:middle line:84% We talk about the fact that we can't really measure utility. 00:26:40.090 --> 00:26:41.810 align:middle line:90% So what do we do as a trick? 00:26:41.810 --> 00:26:45.570 align:middle line:84% What we do is we use a compensating variation measure, 00:26:45.570 --> 00:26:47.373 align:middle line:84% or we use a revealed preference measure. 00:26:47.373 --> 00:26:49.290 align:middle line:84% Which is we say, well, I can't measure how sad 00:26:49.290 --> 00:26:50.590 align:middle line:90% I am to have the dirt pile. 00:26:50.590 --> 00:26:52.173 align:middle line:84% But you can ask me, how much would you 00:26:52.173 --> 00:26:54.050 align:middle line:90% pay to remove the dirt pile? 00:26:54.050 --> 00:26:56.290 align:middle line:90% So this is what I would pay. 00:26:56.290 --> 00:27:00.057 align:middle line:84% So if this was over $1,000, then I could just remove it. 00:27:00.057 --> 00:27:02.390 align:middle line:84% Because if it's than $1,000, I'm not going to remove it. 00:27:02.390 --> 00:27:05.010 align:middle line:84% But added together, it'd would be 00:27:05.010 --> 00:27:06.510 align:middle line:84% worth it to have that thing removed. 00:27:06.510 --> 00:27:08.277 align:middle line:84% So this is a valuation of my utility. 00:27:08.277 --> 00:27:09.110 align:middle line:90% We can't measure it. 00:27:09.110 --> 00:27:10.310 align:middle line:90% We don't measure utility. 00:27:10.310 --> 00:27:13.090 align:middle line:84% We measure the equivalent variation, the dollar value 00:27:13.090 --> 00:27:14.450 align:middle line:90% of that utility. 00:27:14.450 --> 00:27:16.290 align:middle line:84% And that's how we do welfare analysis. 00:27:16.290 --> 00:27:16.910 align:middle line:90% Good question. 00:27:16.910 --> 00:27:19.290 align:middle line:84% Good reminder about a lesson 14.01. 00:27:19.290 --> 00:27:22.060 align:middle line:90% Other questions about this? 00:27:22.060 --> 00:27:27.240 align:middle line:84% Now, you may look at this and you may say-- 00:27:27.240 --> 00:27:30.060 align:middle line:90% 00:27:30.060 --> 00:27:33.080 align:middle line:84% oh, I actually want to talk about one example. 00:27:33.080 --> 00:27:35.420 align:middle line:84% One of my favorite examples of negative externalities-- 00:27:35.420 --> 00:27:37.670 align:middle line:84% because it's really just something we don't appreciate 00:27:37.670 --> 00:27:40.300 align:middle line:84% and incredibly pernicious-- is SUVs. 00:27:40.300 --> 00:27:43.040 align:middle line:84% SUVs are a classic example of a negative externality. 00:27:43.040 --> 00:27:44.060 align:middle line:90% Why? 00:27:44.060 --> 00:27:46.280 align:middle line:84% Because SUVs-- well, you tell me. 00:27:46.280 --> 00:27:48.820 align:middle line:84% What are the ways in which SUVs impose 00:27:48.820 --> 00:27:50.585 align:middle line:84% negative externalities on society, 00:27:50.585 --> 00:27:51.960 align:middle line:84% above and beyond what people pay? 00:27:51.960 --> 00:27:52.760 align:middle line:90% Yeah. 00:27:52.760 --> 00:27:54.797 align:middle line:84% AUDIENCE: They use more gas, they're higher-- 00:27:54.797 --> 00:27:55.880 align:middle line:90% JON GRUBER: Well, hold on. 00:27:55.880 --> 00:27:56.900 align:middle line:90% They use more gas. 00:27:56.900 --> 00:28:00.100 align:middle line:84% And use more gas is bad because it's bad for the environment. 00:28:00.100 --> 00:28:02.300 align:middle line:84% AUDIENCE: They're higher up, so [INAUDIBLE]. 00:28:02.300 --> 00:28:04.340 align:middle line:84% JON GRUBER: They are much less safe. 00:28:04.340 --> 00:28:06.818 align:middle line:84% AUDIENCE: They also take up more space. 00:28:06.818 --> 00:28:08.360 align:middle line:84% JON GRUBER: I don't know that space-- 00:28:08.360 --> 00:28:10.320 align:middle line:84% I mean, I don't know how big that deal is. 00:28:10.320 --> 00:28:11.487 align:middle line:90% But there's one other thing. 00:28:11.487 --> 00:28:12.040 align:middle line:90% Yeah. 00:28:12.040 --> 00:28:13.820 align:middle line:84% AUDIENCE: They're heavier, so they damage the road more. 00:28:13.820 --> 00:28:14.528 align:middle line:90% JON GRUBER: Yeah. 00:28:14.528 --> 00:28:17.220 align:middle line:84% It turns out-- in a fun MIT-ish fact-- turns out 00:28:17.220 --> 00:28:19.180 align:middle line:84% road damage goes up exponentially 00:28:19.180 --> 00:28:21.760 align:middle line:90% with weight per axle. 00:28:21.760 --> 00:28:25.020 align:middle line:84% So if you have more weight on a given set of axles, 00:28:25.020 --> 00:28:26.900 align:middle line:84% road damage goes up exponentially. 00:28:26.900 --> 00:28:29.040 align:middle line:90% And in fact, that's happened. 00:28:29.040 --> 00:28:33.300 align:middle line:84% So in 1985, the typical car weighed 3,200-- 00:28:33.300 --> 00:28:35.300 align:middle line:84% you don't need to memorize this, just fun facts. 00:28:35.300 --> 00:28:39.480 align:middle line:84% Typical car weighed 3,200 pounds and the biggest car on the road 00:28:39.480 --> 00:28:41.640 align:middle line:90% weighed 4,600 pounds. 00:28:41.640 --> 00:28:44.677 align:middle line:84% Now the typical car weighs 4,000 pounds and the biggest truck 00:28:44.677 --> 00:28:46.260 align:middle line:84% on the road-- this is pre-Cybertrucks, 00:28:46.260 --> 00:28:47.720 align:middle line:84% I know what the hell they weigh-- 00:28:47.720 --> 00:28:50.540 align:middle line:90% is 6,600 pounds. 00:28:50.540 --> 00:28:57.640 align:middle line:84% We have massively- fuel economy, the typical SUV gets about 2/3 00:28:57.640 --> 00:29:02.320 align:middle line:84% the fuel efficiency of a sedan, not even of a compact. 00:29:02.320 --> 00:29:06.320 align:middle line:90% So they're inefficient. 00:29:06.320 --> 00:29:07.492 align:middle line:90% They consume more gas. 00:29:07.492 --> 00:29:09.700 align:middle line:84% That's an externality through causing global warming. 00:29:09.700 --> 00:29:11.240 align:middle line:90% They're Bangladesh killers. 00:29:11.240 --> 00:29:11.960 align:middle line:90% OK? 00:29:11.960 --> 00:29:14.840 align:middle line:84% Second, they do more damage to the road 00:29:14.840 --> 00:29:18.000 align:middle line:84% because road damage goes up with weight per axle exponentially. 00:29:18.000 --> 00:29:20.900 align:middle line:84% And third, and actually most interestingly, 00:29:20.900 --> 00:29:22.120 align:middle line:90% they're incredibly unsafe. 00:29:22.120 --> 00:29:23.220 align:middle line:84% And why are they especially unsafe? 00:29:23.220 --> 00:29:25.470 align:middle line:84% Because they're designed where their grills at exactly 00:29:25.470 --> 00:29:27.380 align:middle line:90% the height of people's heads. 00:29:27.380 --> 00:29:31.500 align:middle line:84% So actually, if you look at traffic deaths in the US, 00:29:31.500 --> 00:29:35.060 align:middle line:84% we see a dramatic reduction-- the entire world has 00:29:35.060 --> 00:29:37.780 align:middle line:84% seen a dramatic reduction of driver deaths 00:29:37.780 --> 00:29:40.900 align:middle line:84% from traffic accidents-- driver and passenger deaths. 00:29:40.900 --> 00:29:43.700 align:middle line:84% Dramatic reduction, because cars have gotten safer. 00:29:43.700 --> 00:29:48.300 align:middle line:84% But only in the US that has been offset by a dramatic increase 00:29:48.300 --> 00:29:50.100 align:middle line:90% in pedestrian deaths. 00:29:50.100 --> 00:29:50.977 align:middle line:90% Only in the US. 00:29:50.977 --> 00:29:53.060 align:middle line:84% So while the rest of the world is seeing traffic-- 00:29:53.060 --> 00:29:55.352 align:middle line:84% among developed countries-- while the rest of the world 00:29:55.352 --> 00:29:57.880 align:middle line:84% is seeing traffic deaths fall in general, the US, 00:29:57.880 --> 00:30:00.005 align:middle line:84% they've fallen a little bit, but not nearly as much 00:30:00.005 --> 00:30:02.713 align:middle line:84% as the rest of the world because our savings in driver fatalities 00:30:02.713 --> 00:30:04.480 align:middle line:84% are being offset by pedestrian fatalities 00:30:04.480 --> 00:30:05.940 align:middle line:84% because we have these grills at exactly head height 00:30:05.940 --> 00:30:07.300 align:middle line:90% and they're killing people. 00:30:07.300 --> 00:30:08.925 align:middle line:84% Moreover, what's fascinating about this 00:30:08.925 --> 00:30:11.260 align:middle line:84% is it's what we call a dynamic externality, 00:30:11.260 --> 00:30:13.040 align:middle line:84% because since you're driving a big car, 00:30:13.040 --> 00:30:15.100 align:middle line:90% I got to drive a big car. 00:30:15.100 --> 00:30:17.230 align:middle line:84% So as this dynamic effect of reinforcing itself 00:30:17.230 --> 00:30:18.730 align:middle line:84% that when somebody's driving an SUV, 00:30:18.730 --> 00:30:20.980 align:middle line:84% you want to drive an SUV because you don't want to get 00:30:20.980 --> 00:30:21.830 align:middle line:90% hit by this SUV. 00:30:21.830 --> 00:30:27.030 align:middle line:84% So that's basically a perfect example 00:30:27.030 --> 00:30:31.430 align:middle line:90% of a negative externality. 00:30:31.430 --> 00:30:36.712 align:middle line:84% Now, if we go back, let's go back to my neighbor's dirt pile. 00:30:36.712 --> 00:30:39.170 align:middle line:84% Now, you might say-- you hear that example and you're like, 00:30:39.170 --> 00:30:42.230 align:middle line:84% well Jon, this is a course about the government. 00:30:42.230 --> 00:30:46.110 align:middle line:84% But that seems like you could solve it privately. 00:30:46.110 --> 00:30:47.750 align:middle line:90% Just go to your neighbor. 00:30:47.750 --> 00:30:50.290 align:middle line:84% It's like, look, it's $1,000 for this. 00:30:50.290 --> 00:30:51.842 align:middle line:90% I know it's worth $600 to you. 00:30:51.842 --> 00:30:53.050 align:middle line:90% I know it's worth $500 to me. 00:30:53.050 --> 00:30:54.790 align:middle line:84% Let's just pool together and let's just 00:30:54.790 --> 00:30:56.350 align:middle line:90% get rid of this dirt pile. 00:30:56.350 --> 00:31:00.990 align:middle line:84% And indeed, there's a famous example 00:31:00.990 --> 00:31:04.110 align:middle line:84% of applying this, which is what's 00:31:04.110 --> 00:31:11.230 align:middle line:84% called the Coase theorem, named after the economist Ronald Coase 00:31:11.230 --> 00:31:15.070 align:middle line:90% from the University of Chicago. 00:31:15.070 --> 00:31:19.850 align:middle line:84% He said, look, let's go back to our first example. 00:31:19.850 --> 00:31:22.810 align:middle line:84% Let's go back to the steel plant. 00:31:22.810 --> 00:31:25.510 align:middle line:90% And let's look at that example. 00:31:25.510 --> 00:31:30.850 align:middle line:84% And he says, what if the fishermen owned the river? 00:31:30.850 --> 00:31:32.330 align:middle line:84% What if fishermen owned the river? 00:31:32.330 --> 00:31:34.650 align:middle line:84% They would march up to the steel plant owner 00:31:34.650 --> 00:31:36.530 align:middle line:84% and they'd say, look, steel plant owner, 00:31:36.530 --> 00:31:40.758 align:middle line:84% you need to produce less steel, because you are-- 00:31:40.758 --> 00:31:43.050 align:middle line:84% and by the way, we'll come later to pollution reduction 00:31:43.050 --> 00:31:43.610 align:middle line:90% technologies. 00:31:43.610 --> 00:31:45.190 align:middle line:84% Imagine there's no pollution reduction technology. 00:31:45.190 --> 00:31:47.490 align:middle line:84% The only way to reduce the sludge is to produce less. 00:31:47.490 --> 00:31:50.110 align:middle line:84% We'll come back to pollution reduction technology. 00:31:50.110 --> 00:31:51.730 align:middle line:84% But for now, imagine the only way to reduce the pollution 00:31:51.730 --> 00:31:52.710 align:middle line:90% is to produce less. 00:31:52.710 --> 00:31:55.085 align:middle line:84% The fishermen would come and say, look, we own the river. 00:31:55.085 --> 00:32:02.530 align:middle line:84% We will not let you dump unless you reduce the amount 00:32:02.530 --> 00:32:05.530 align:middle line:84% or unless you pay us the damage that you're doing. 00:32:05.530 --> 00:32:07.030 align:middle line:84% So they say look, steel plant owner, 00:32:07.030 --> 00:32:08.350 align:middle line:84% we don't want to mess with your production process. 00:32:08.350 --> 00:32:09.225 align:middle line:90% You know what's best. 00:32:09.225 --> 00:32:12.770 align:middle line:84% But we want you to pay us D for every unit of steel 00:32:12.770 --> 00:32:18.310 align:middle line:84% you produce to compensate us for the fish that are dying. 00:32:18.310 --> 00:32:21.923 align:middle line:84% Well, think about what that does. 00:32:21.923 --> 00:32:24.090 align:middle line:84% Think about what that does to the steel plant owner. 00:32:24.090 --> 00:32:25.070 align:middle line:84% So we've got, once again, the market 00:32:25.070 --> 00:32:26.750 align:middle line:90% for steel-- quantity, price. 00:32:26.750 --> 00:32:29.270 align:middle line:84% We've got our private marginal benefit. 00:32:29.270 --> 00:32:31.530 align:middle line:84% We've got our private marginal cost. 00:32:31.530 --> 00:32:33.710 align:middle line:84% We've got our social marginal cost. 00:32:33.710 --> 00:32:36.110 align:middle line:84% We've got the private market quantity 00:32:36.110 --> 00:32:39.670 align:middle line:90% and the optimal public quantity. 00:32:39.670 --> 00:32:41.470 align:middle line:90% OK? 00:32:41.470 --> 00:32:45.510 align:middle line:84% And we have some damage D that the production of steel 00:32:45.510 --> 00:32:46.310 align:middle line:90% is doing. 00:32:46.310 --> 00:32:47.890 align:middle line:84% We actually have our handout now. 00:32:47.890 --> 00:32:49.450 align:middle line:90% Thank you, Valerie. 00:32:49.450 --> 00:32:52.070 align:middle line:84% Valerie biked all the way back to the department. 00:32:52.070 --> 00:32:55.030 align:middle line:90% So now we can go to figure 5-5. 00:32:55.030 --> 00:32:58.590 align:middle line:90% 00:32:58.590 --> 00:33:02.150 align:middle line:84% Here I have a marginal damage of, say, 100. 00:33:02.150 --> 00:33:08.990 align:middle line:84% Now, so what if the marginal damage was 100? 00:33:08.990 --> 00:33:12.383 align:middle line:84% And what if the fishermen said to the steel plant owner, well, 00:33:12.383 --> 00:33:14.800 align:middle line:84% you got to pay us 100 for every unit of steel you produce. 00:33:14.800 --> 00:33:16.320 align:middle line:90% What does that do? 00:33:16.320 --> 00:33:20.360 align:middle line:84% Well, that internalizes the externality. 00:33:20.360 --> 00:33:22.440 align:middle line:84% What mean by that is the steel plant owner now 00:33:22.440 --> 00:33:24.920 align:middle line:84% has a higher private marginal cost. 00:33:24.920 --> 00:33:29.280 align:middle line:84% It's the original marginal cost plus the $100 they have to pay. 00:33:29.280 --> 00:33:31.780 align:middle line:84% And guess what, that new private marginal cost, 00:33:31.780 --> 00:33:34.800 align:middle line:84% which in figure 5-5 we call PMC2, 00:33:34.800 --> 00:33:38.960 align:middle line:84% is equal to the social marginal cost. 00:33:38.960 --> 00:33:41.440 align:middle line:84% So the new private marginal cost is 00:33:41.440 --> 00:33:44.140 align:middle line:84% equal to the social marginal cost. 00:33:44.140 --> 00:33:47.320 align:middle line:84% And there's no more externality because the steel plant now 00:33:47.320 --> 00:33:50.520 align:middle line:90% produces optimally at Q2. 00:33:50.520 --> 00:33:52.920 align:middle line:84% OK, once again, the steel plant has 00:33:52.920 --> 00:33:55.120 align:middle line:84% to pay the fishermen $100 for every unit of steel 00:33:55.120 --> 00:33:56.840 align:middle line:90% they produce. 00:33:56.840 --> 00:34:00.557 align:middle line:84% That equates their new private marginal cost 00:34:00.557 --> 00:34:02.640 align:middle line:84% with the social marginal cost, and there's no more 00:34:02.640 --> 00:34:05.760 align:middle line:90% overproduction of steel. 00:34:05.760 --> 00:34:08.880 align:middle line:84% This indeed is the proof-- is a graphical proof of what 00:34:08.880 --> 00:34:11.120 align:middle line:90% we call the Coase theorem. 00:34:11.120 --> 00:34:16.060 align:middle line:84% The Coase theorem states that as long as property rights are 00:34:16.060 --> 00:34:18.780 align:middle line:84% well-defined-- as long as you have well-defined property 00:34:18.780 --> 00:34:20.380 align:middle line:90% rights-- 00:34:20.380 --> 00:34:25.139 align:middle line:84% property rights are well-defined, 00:34:25.139 --> 00:34:35.580 align:middle line:84% and as long as you have costless and efficient bargaining, 00:34:35.580 --> 00:34:38.420 align:middle line:84% if those conditions are met, then there 00:34:38.420 --> 00:34:41.165 align:middle line:90% will be no externalities. 00:34:41.165 --> 00:34:43.540 align:middle line:84% Externalities will all be internalized through the market 00:34:43.540 --> 00:34:45.340 align:middle line:90% mechanism. 00:34:45.340 --> 00:34:47.487 align:middle line:84% Unsurprisingly, this guy was in Chicago. 00:34:47.487 --> 00:34:49.320 align:middle line:84% If you know the history of economic thought, 00:34:49.320 --> 00:34:50.300 align:middle line:90% there's a big-- 00:34:50.300 --> 00:34:51.854 align:middle line:84% Chicago's very pro-market, Cambridge 00:34:51.854 --> 00:34:53.146 align:middle line:90% is sort of more pro-government. 00:34:53.146 --> 00:34:54.229 align:middle line:90% That's kind of the debate. 00:34:54.229 --> 00:34:56.620 align:middle line:84% So this is very much within the Chicago school of thought 00:34:56.620 --> 00:34:59.180 align:middle line:84% that, in fact, you don't need the government here, 00:34:59.180 --> 00:35:01.400 align:middle line:84% because in fact, there's no externality. 00:35:01.400 --> 00:35:05.900 align:middle line:84% They just internalized it and we're done. 00:35:05.900 --> 00:35:08.840 align:middle line:90% OK, so that is Coase. 00:35:08.840 --> 00:35:12.280 align:middle line:84% Actually, Coase theorem has a part two that's kind of cool. 00:35:12.280 --> 00:35:14.480 align:middle line:84% Coase theorem part two-- that's part one. 00:35:14.480 --> 00:35:17.720 align:middle line:84% Part two says it actually doesn't matter 00:35:17.720 --> 00:35:18.942 align:middle line:90% who has the property rights. 00:35:18.942 --> 00:35:20.900 align:middle line:84% Note, I didn't say who has the property rights. 00:35:20.900 --> 00:35:23.320 align:middle line:84% I just said they have to be defined. 00:35:23.320 --> 00:35:28.120 align:middle line:84% So imagine the steel plant owner owned the river. 00:35:28.120 --> 00:35:30.560 align:middle line:84% Well, then the fishermen could come up to him 00:35:30.560 --> 00:35:34.960 align:middle line:84% and pay him $100 not to produce the unit of steel. 00:35:34.960 --> 00:35:37.150 align:middle line:90% And we get the same equilibrium. 00:35:37.150 --> 00:35:38.900 align:middle line:84% Now, of course, they wouldn't pay him 100. 00:35:38.900 --> 00:35:40.720 align:middle line:90% They'd want to pay him 99.9. 00:35:40.720 --> 00:35:42.220 align:middle line:84% Of course, he wouldn't pay them 100. 00:35:42.220 --> 00:35:43.720 align:middle line:90% You'd pay them 99.9. 00:35:43.720 --> 00:35:46.040 align:middle line:90% So I'm using 100 to round. 00:35:46.040 --> 00:35:48.800 align:middle line:84% But roughly speaking, the point is, as long 00:35:48.800 --> 00:35:50.300 align:middle line:84% as property rights are well-defined, 00:35:50.300 --> 00:35:53.060 align:middle line:84% whoever owns the property rights will get the benefits. 00:35:53.060 --> 00:35:54.620 align:middle line:90% It will determine distribution. 00:35:54.620 --> 00:35:57.040 align:middle line:84% In the first case, the fishermen are better off. 00:35:57.040 --> 00:35:59.600 align:middle line:84% In the second case, the steel plant is better off. 00:35:59.600 --> 00:36:01.573 align:middle line:84% But in both cases, you get efficiency. 00:36:01.573 --> 00:36:02.990 align:middle line:84% And that's, once again, an example 00:36:02.990 --> 00:36:05.600 align:middle line:84% where you have to keep your mind separated between efficiency 00:36:05.600 --> 00:36:06.700 align:middle line:90% and redistribution. 00:36:06.700 --> 00:36:08.700 align:middle line:84% We're not talking about winners and losers here. 00:36:08.700 --> 00:36:10.170 align:middle line:90% We're talking about efficiency. 00:36:10.170 --> 00:36:11.290 align:middle line:90% Yeah. 00:36:11.290 --> 00:36:13.890 align:middle line:84% AUDIENCE: What specifically does the word well-defined-- 00:36:13.890 --> 00:36:15.630 align:middle line:90% or what does it mean-- 00:36:15.630 --> 00:36:17.450 align:middle line:84% JON GRUBER: Somebody owns the river. 00:36:17.450 --> 00:36:20.010 align:middle line:84% There's an enforceable contract that you own the river. 00:36:20.010 --> 00:36:22.730 align:middle line:84% That if I do not get permission to use the steel plant to dump 00:36:22.730 --> 00:36:25.570 align:middle line:84% in the river, and you do, you will be shut down 00:36:25.570 --> 00:36:28.570 align:middle line:84% or you'll be subject to some extreme fine. 00:36:28.570 --> 00:36:31.970 align:middle line:84% AUDIENCE: Sure, so the examples of some sort of shared ownership 00:36:31.970 --> 00:36:34.330 align:middle line:84% or government ownership, do they fall under that? 00:36:34.330 --> 00:36:35.090 align:middle line:90% No. 00:36:35.090 --> 00:36:36.852 align:middle line:84% Well, I mean, that's a complicated case. 00:36:36.852 --> 00:36:38.810 align:middle line:84% But the bottom line is you need property rights 00:36:38.810 --> 00:36:40.210 align:middle line:90% to be well-defined. 00:36:40.210 --> 00:36:43.930 align:middle line:84% JON GRUBER: So Coase's point is, just 00:36:43.930 --> 00:36:46.490 align:middle line:84% because there's this externality doesn't 00:36:46.490 --> 00:36:48.610 align:middle line:90% mean you need the government. 00:36:48.610 --> 00:36:50.650 align:middle line:84% As long as you just define property rights 00:36:50.650 --> 00:36:53.610 align:middle line:84% and you allow people to bargain, they'll figure it out. 00:36:53.610 --> 00:36:57.410 align:middle line:84% Now, this is an example of a trick we'll use several times 00:36:57.410 --> 00:37:01.290 align:middle line:84% this semester, which is to lay out 00:37:01.290 --> 00:37:04.130 align:middle line:84% a theory which has a lot of good insights 00:37:04.130 --> 00:37:07.610 align:middle line:84% but is clearly wrong in application. 00:37:07.610 --> 00:37:09.630 align:middle line:84% The Coase theorem is very valuable for thinking 00:37:09.630 --> 00:37:10.690 align:middle line:90% about lots of things. 00:37:10.690 --> 00:37:14.010 align:middle line:84% It also almost never actually works. 00:37:14.010 --> 00:37:15.590 align:middle line:90% And why does it not work? 00:37:15.590 --> 00:37:18.270 align:middle line:84% Well, there's a number of problems with the Coase theorem. 00:37:18.270 --> 00:37:23.150 align:middle line:84% The first problem is what we call the assignment problem. 00:37:23.150 --> 00:37:28.630 align:middle line:84% The assignment problem is that basically when 00:37:28.630 --> 00:37:35.710 align:middle line:84% you have many bad actors and many people being hurt, 00:37:35.710 --> 00:37:38.650 align:middle line:84% you don't know how to assign blame or how to assign benefits. 00:37:38.650 --> 00:37:40.970 align:middle line:84% So let's say there's six steel plants along the river, 00:37:40.970 --> 00:37:41.950 align:middle line:84% and you don't know which steel plant 00:37:41.950 --> 00:37:43.430 align:middle line:90% sludge is killing your fish. 00:37:43.430 --> 00:37:45.750 align:middle line:90% How do you know who to charge? 00:37:45.750 --> 00:37:48.910 align:middle line:84% Or let's say there's three pods of fishermen. 00:37:48.910 --> 00:37:51.190 align:middle line:84% How does each pod of fishermen get paid? 00:37:51.190 --> 00:37:53.730 align:middle line:84% So whenever there's multiple players, 00:37:53.730 --> 00:37:55.910 align:middle line:90% you have an assignment problem. 00:37:55.910 --> 00:38:00.990 align:middle line:84% There's also the problem that we don't 00:38:00.990 --> 00:38:02.872 align:middle line:90% know how much the damage is. 00:38:02.872 --> 00:38:04.830 align:middle line:84% The fishermen could go to the steel plant owner 00:38:04.830 --> 00:38:06.663 align:middle line:84% and say you're doing $100 of damage to fish. 00:38:06.663 --> 00:38:07.490 align:middle line:90% How do we know? 00:38:07.490 --> 00:38:09.032 align:middle line:84% How is the steel plant owner supposed 00:38:09.032 --> 00:38:11.010 align:middle line:90% to verify that and know? 00:38:11.010 --> 00:38:12.610 align:middle line:84% So basically, the first problem is 00:38:12.610 --> 00:38:15.300 align:middle line:84% we don't know how to assign the benefits and the costs 00:38:15.300 --> 00:38:18.730 align:middle line:84% in a way that will make it seem easily theoretically here. 00:38:18.730 --> 00:38:23.290 align:middle line:84% Think about how this gets worse with climate change. 00:38:23.290 --> 00:38:26.890 align:middle line:84% Remember, every single unit of carbon emitted anywhere 00:38:26.890 --> 00:38:30.930 align:middle line:84% in the world has an equal effect on climate change. 00:38:30.930 --> 00:38:33.490 align:middle line:84% So how could you possibly negotiate 00:38:33.490 --> 00:38:36.290 align:middle line:84% with every single person emitting carbon at every point 00:38:36.290 --> 00:38:38.370 align:middle line:84% and every single person being damaged, 00:38:38.370 --> 00:38:40.870 align:middle line:90% and some being benefited? 00:38:40.870 --> 00:38:41.370 align:middle line:90% Right? 00:38:41.370 --> 00:38:42.930 align:middle line:84% Duluth, Minnesota advertising itself 00:38:42.930 --> 00:38:45.410 align:middle line:84% as the climate refuge of the world. 00:38:45.410 --> 00:38:47.430 align:middle line:84% We're now are growing grains in Siberia that 00:38:47.430 --> 00:38:48.750 align:middle line:90% were never possible before. 00:38:48.750 --> 00:38:50.850 align:middle line:84% Some folks are benefiting from global warming. 00:38:50.850 --> 00:38:51.910 align:middle line:90% Most are losing. 00:38:51.910 --> 00:38:54.050 align:middle line:84% How would you possibly arrange that negotiation? 00:38:54.050 --> 00:38:56.010 align:middle line:90% It's implausible. 00:38:56.010 --> 00:38:59.210 align:middle line:90% So that's one problem. 00:38:59.210 --> 00:39:03.390 align:middle line:84% The second problem is what we call the holdout problem. 00:39:03.390 --> 00:39:06.540 align:middle line:90% 00:39:06.540 --> 00:39:10.443 align:middle line:84% OK, imagine that we've solved this assignment problem. 00:39:10.443 --> 00:39:11.360 align:middle line:90% We figured it all out. 00:39:11.360 --> 00:39:12.780 align:middle line:90% We know what's going on. 00:39:12.780 --> 00:39:17.820 align:middle line:84% And let's say that we've decided that there are 100 fishermen, 00:39:17.820 --> 00:39:20.900 align:middle line:84% and each unit of sludge kills $1's 00:39:20.900 --> 00:39:24.220 align:middle line:84% worth of fish for each of the 100 fishermen. 00:39:24.220 --> 00:39:26.780 align:middle line:90% Thus, the $100 damage. 00:39:26.780 --> 00:39:30.300 align:middle line:84% Now, the fishermen go up to the steel plant, 00:39:30.300 --> 00:39:33.300 align:middle line:84% and they say you have to give us each $1, 00:39:33.300 --> 00:39:35.920 align:middle line:90% or you can't use the river. 00:39:35.920 --> 00:39:37.620 align:middle line:84% We have property rights on the river. 00:39:37.620 --> 00:39:39.620 align:middle line:90% You can't use the river. 00:39:39.620 --> 00:39:43.820 align:middle line:84% Well, let's say Enoch here is the 100th fisherman. 00:39:43.820 --> 00:39:47.380 align:middle line:84% Now, the other 99 have gotten their dollar. 00:39:47.380 --> 00:39:49.340 align:middle line:90% Now he's the last fisherman. 00:39:49.340 --> 00:39:52.060 align:middle line:84% The steel plant can't produce unless he also says yes. 00:39:52.060 --> 00:39:53.860 align:middle line:90% Is he going to ask for a dollar? 00:39:53.860 --> 00:39:56.820 align:middle line:90% No, he's going to ask for $50. 00:39:56.820 --> 00:39:59.660 align:middle line:84% He'd be like, look, you've already given away $99. 00:39:59.660 --> 00:40:01.820 align:middle line:90% I have all the power now. 00:40:01.820 --> 00:40:03.368 align:middle line:84% You have all the negotiating power. 00:40:03.368 --> 00:40:04.160 align:middle line:90% You're the holdout. 00:40:04.160 --> 00:40:05.993 align:middle line:84% Well, working backwards, the first fishermen 00:40:05.993 --> 00:40:08.400 align:middle line:84% should see that coming and should also not settle for $1, 00:40:08.400 --> 00:40:09.920 align:middle line:90% and the whole thing falls apart. 00:40:09.920 --> 00:40:14.400 align:middle line:84% Classic problem with negotiation is this holdout problem. 00:40:14.400 --> 00:40:15.560 align:middle line:90% OK? 00:40:15.560 --> 00:40:21.528 align:middle line:84% The flip side of that is what we call the free rider problem. 00:40:21.528 --> 00:40:23.320 align:middle line:84% And this is a term we'll come back to a lot 00:40:23.320 --> 00:40:27.560 align:middle line:84% this semester, the free rider problem. 00:40:27.560 --> 00:40:31.193 align:middle line:84% Which is that, what if we said, OK, fine, 00:40:31.193 --> 00:40:32.860 align:middle line:84% that holdout problem is going to be bad. 00:40:32.860 --> 00:40:34.985 align:middle line:84% So let's say the steel plant owner had the problem. 00:40:34.985 --> 00:40:36.980 align:middle line:84% OK, let's forget Coase theorem part two. 00:40:36.980 --> 00:40:38.540 align:middle line:84% What about Coase theorem part one? 00:40:38.540 --> 00:40:40.623 align:middle line:84% What if the steel plant holds the property rights? 00:40:40.623 --> 00:40:43.600 align:middle line:90% Would that solve the problem? 00:40:43.600 --> 00:40:49.160 align:middle line:84% Now, the problem if the steel plant holds the property rights 00:40:49.160 --> 00:40:52.400 align:middle line:90% is that basically-- 00:40:52.400 --> 00:40:53.920 align:middle line:84% so let's say they have the rights 00:40:53.920 --> 00:40:57.480 align:middle line:84% and they agree to reduce production by one unit 00:40:57.480 --> 00:41:00.360 align:middle line:84% for every $100 they get from the fishermen. 00:41:00.360 --> 00:41:09.260 align:middle line:84% Now basically, suppose that they agree that-- 00:41:09.260 --> 00:41:11.740 align:middle line:84% let's say the optimal reduction is 100 units, 00:41:11.740 --> 00:41:14.860 align:middle line:84% that the social optimum is they produce 100 units. 00:41:14.860 --> 00:41:17.417 align:middle line:84% So they're going to get $100 from the fishermen 00:41:17.417 --> 00:41:18.000 align:middle line:90% for each unit. 00:41:18.000 --> 00:41:20.980 align:middle line:84% They're going to get $10,000 from the fishermen. 00:41:20.980 --> 00:41:25.340 align:middle line:84% So each fisherman goes and pays his $100. 00:41:25.340 --> 00:41:26.020 align:middle line:90% OK? 00:41:26.020 --> 00:41:28.420 align:middle line:84% Well, now you're the last fisherman. 00:41:28.420 --> 00:41:31.080 align:middle line:84% Enoch again, he's the last fisherman. 00:41:31.080 --> 00:41:33.380 align:middle line:84% All the other fishermen have paid $100. 00:41:33.380 --> 00:41:36.040 align:middle line:84% He comes up and he says, well look, if I don't pay, 00:41:36.040 --> 00:41:38.360 align:middle line:90% you still reduce 99 units. 00:41:38.360 --> 00:41:40.840 align:middle line:84% And I'll get 99/100 of the benefit. 00:41:40.840 --> 00:41:42.580 align:middle line:90% So why should I pay you? 00:41:42.580 --> 00:41:47.180 align:middle line:84% I'm a free rider, because it's a private cost 00:41:47.180 --> 00:41:49.020 align:middle line:90% and a social benefit. 00:41:49.020 --> 00:41:51.200 align:middle line:84% When the steel plant reduces dumping sludge, 00:41:51.200 --> 00:41:53.660 align:middle line:90% all the fishermen benefit. 00:41:53.660 --> 00:41:55.803 align:middle line:84% As a result, why should any one fisherman pony up? 00:41:55.803 --> 00:41:58.220 align:middle line:84% They should try to get all the other fishermen to pony up. 00:41:58.220 --> 00:42:00.020 align:middle line:84% So that same logic again unravels 00:42:00.020 --> 00:42:02.630 align:middle line:90% and no fisherman will pony up. 00:42:02.630 --> 00:42:03.510 align:middle line:90% OK? 00:42:03.510 --> 00:42:04.510 align:middle line:90% Yeah. 00:42:04.510 --> 00:42:08.070 align:middle line:84% AUDIENCE: So would the last fisherman would say? 00:42:08.070 --> 00:42:10.370 align:middle line:84% JON GRUBER: So the way I set this up, 00:42:10.370 --> 00:42:14.650 align:middle line:84% the output needs to reduce 100 units of steel. 00:42:14.650 --> 00:42:18.727 align:middle line:84% So each fisherman should pay you $100 to reduce the unit. 00:42:18.727 --> 00:42:19.810 align:middle line:90% So they all get in a line. 00:42:19.810 --> 00:42:21.083 align:middle line:90% They each give you $100. 00:42:21.083 --> 00:42:22.750 align:middle line:84% The last fisherman says, well, 99 people 00:42:22.750 --> 00:42:24.590 align:middle line:90% have given you that money. 00:42:24.590 --> 00:42:26.910 align:middle line:84% I know you're reduced by 99 units. 00:42:26.910 --> 00:42:29.470 align:middle line:84% If I give you my 100, you reduce by the 100th unit. 00:42:29.470 --> 00:42:32.770 align:middle line:84% But I only get 1/100 of the benefit of that, 00:42:32.770 --> 00:42:35.230 align:middle line:90% whereas I bear all the cost. 00:42:35.230 --> 00:42:36.910 align:middle line:84% So I'm not going to give you the money. 00:42:36.910 --> 00:42:39.150 align:middle line:84% And that's the free rider problem. 00:42:39.150 --> 00:42:41.030 align:middle line:84% And then finally, we have the problems 00:42:41.030 --> 00:42:43.270 align:middle line:84% with this other assumption, which is bargaining 00:42:43.270 --> 00:42:44.610 align:middle line:90% is not costless and efficient. 00:42:44.610 --> 00:42:46.850 align:middle line:90% So we have bargaining problems. 00:42:46.850 --> 00:42:49.350 align:middle line:84% I already talked about one kind of bargaining problem, which 00:42:49.350 --> 00:42:52.310 align:middle line:84% is, how you get all the people affected by climate change 00:42:52.310 --> 00:42:52.850 align:middle line:90% together? 00:42:52.850 --> 00:42:56.250 align:middle line:84% But let's just think about my neighbor and I. In fact, 00:42:56.250 --> 00:42:58.850 align:middle line:84% it'd be super fucking weird if I went to him and said, well, 00:42:58.850 --> 00:43:01.630 align:middle line:84% it's worth $600 to you and I'll give you $500, it's $1,000-- 00:43:01.630 --> 00:43:05.530 align:middle line:84% I mean, he'd punch me in the face. 00:43:05.530 --> 00:43:06.350 align:middle line:90% Think about it. 00:43:06.350 --> 00:43:07.870 align:middle line:84% Think about a classic externality, 00:43:07.870 --> 00:43:11.290 align:middle line:84% which is the person next door to you plays their music too loud. 00:43:11.290 --> 00:43:13.550 align:middle line:90% You do one of two things. 00:43:13.550 --> 00:43:15.142 align:middle line:84% You either ignore it or you complain 00:43:15.142 --> 00:43:17.350 align:middle line:84% and make them shut it off-- tell them to shut it off. 00:43:17.350 --> 00:43:19.850 align:middle line:84% You don't calculate the loss in lifetime earnings 00:43:19.850 --> 00:43:21.600 align:middle line:84% and say, well look, if you want to pay it, 00:43:21.600 --> 00:43:23.730 align:middle line:90% you've got to pay me $6.63. 00:43:23.730 --> 00:43:27.070 align:middle line:84% Basically, that's just not how the world works. 00:43:27.070 --> 00:43:28.690 align:middle line:84% There's a famous apocalyptic tale 00:43:28.690 --> 00:43:31.530 align:middle line:84% of an economist on a plane-- who shall remain nameless-- 00:43:31.530 --> 00:43:33.490 align:middle line:84% who offered the guy next to him $10 to shut up 00:43:33.490 --> 00:43:35.640 align:middle line:90% so he could get some sleep. 00:43:35.640 --> 00:43:37.890 align:middle line:84% That's apocalyptic, because it probably didn't happen. 00:43:37.890 --> 00:43:41.110 align:middle line:84% So the point is, the Coase theorem is great in theory, 00:43:41.110 --> 00:43:43.810 align:middle line:84% and it's a valuable insight in theory. 00:43:43.810 --> 00:43:47.330 align:middle line:84% In practice, that's just not how things work. 00:43:47.330 --> 00:43:48.250 align:middle line:90% OK? 00:43:48.250 --> 00:43:49.690 align:middle line:90% Questions about that. 00:43:49.690 --> 00:43:51.290 align:middle line:90% Yeah. 00:43:51.290 --> 00:43:51.990 align:middle line:90% Oh, go ahead. 00:43:51.990 --> 00:43:55.162 align:middle line:84% AUDIENCE: Why is the holdout different from the free rider? 00:43:55.162 --> 00:43:57.870 align:middle line:84% JON GRUBER: It's basically which side of the problem you look at. 00:43:57.870 --> 00:43:59.890 align:middle line:84% I mean, Enoch's the bad guy in either example. 00:43:59.890 --> 00:44:02.910 align:middle line:84% But the holdout problem is when the property right 00:44:02.910 --> 00:44:05.355 align:middle line:84% owner can hold out and basically say, 00:44:05.355 --> 00:44:07.230 align:middle line:84% I'm not going to give you this property right 00:44:07.230 --> 00:44:09.110 align:middle line:90% unless you pay me the most. 00:44:09.110 --> 00:44:11.550 align:middle line:84% The free rider problem is when the other party has 00:44:11.550 --> 00:44:14.152 align:middle line:84% the ownership, and you say, well, if most of my friends 00:44:14.152 --> 00:44:15.610 align:middle line:84% pay up and they do the right thing, 00:44:15.610 --> 00:44:16.530 align:middle line:90% I'm going to benefit from that. 00:44:16.530 --> 00:44:17.633 align:middle line:90% So why should I pay up? 00:44:17.633 --> 00:44:19.050 align:middle line:84% So it's really which side owns it. 00:44:19.050 --> 00:44:21.573 align:middle line:84% So it's really fighting with part two of the Coase theorem, 00:44:21.573 --> 00:44:22.990 align:middle line:84% saying that the side of the market 00:44:22.990 --> 00:44:24.830 align:middle line:84% matters, but it screws up no matter which-- 00:44:24.830 --> 00:44:25.810 align:middle line:90% it matters who owns it. 00:44:25.810 --> 00:44:26.970 align:middle line:90% It screws up either way. 00:44:26.970 --> 00:44:28.150 align:middle line:90% There's a question here. 00:44:28.150 --> 00:44:28.810 align:middle line:90% Yeah. 00:44:28.810 --> 00:44:31.070 align:middle line:84% AUDIENCE: You were saying that actually they 00:44:31.070 --> 00:44:34.170 align:middle line:90% wouldn't pay 10, but 9.9999. 00:44:34.170 --> 00:44:36.263 align:middle line:90% Why is that? 00:44:36.263 --> 00:44:37.930 align:middle line:84% JON GRUBER: So this is a great question. 00:44:37.930 --> 00:44:41.630 align:middle line:84% So basically, I assumed that it worked out 00:44:41.630 --> 00:44:43.710 align:middle line:90% that you paid exactly 100. 00:44:43.710 --> 00:44:45.230 align:middle line:90% But how does that work out? 00:44:45.230 --> 00:44:47.090 align:middle line:84% I mean, if the fishermen own the river, 00:44:47.090 --> 00:44:49.470 align:middle line:84% why don't they charge a steel plant 150? 00:44:49.470 --> 00:44:51.310 align:middle line:90% Why should they settle for 100? 00:44:51.310 --> 00:44:53.830 align:middle line:84% And in fact, I don't have a good answer to that, other 00:44:53.830 --> 00:44:56.010 align:middle line:84% than if there were multiple groups of fishermen, 00:44:56.010 --> 00:44:58.740 align:middle line:84% they'd bid against each other and drive it down to 100. 00:44:58.740 --> 00:45:00.240 align:middle line:84% So in fact, in this example, I don't 00:45:00.240 --> 00:45:01.407 align:middle line:90% have a good answer for that. 00:45:01.407 --> 00:45:03.440 align:middle line:84% In fact, they probably would ask for 150. 00:45:03.440 --> 00:45:05.400 align:middle line:84% So basically the point is, I'm assuming 00:45:05.400 --> 00:45:10.600 align:middle line:84% we end up at where efficient negotiation would end. 00:45:10.600 --> 00:45:12.400 align:middle line:90% That's what I'm covering there. 00:45:12.400 --> 00:45:13.180 align:middle line:90% Other questions? 00:45:13.180 --> 00:45:13.840 align:middle line:90% Yeah. 00:45:13.840 --> 00:45:15.630 align:middle line:84% AUDIENCE: So I understand both the assignment problem 00:45:15.630 --> 00:45:17.040 align:middle line:90% and the bargaining problem-- 00:45:17.040 --> 00:45:18.707 align:middle line:84% well, part of it comes down to that it's 00:45:18.707 --> 00:45:20.400 align:middle line:90% hard to quantify damage. 00:45:20.400 --> 00:45:23.412 align:middle line:84% Could you a little bit elaborate on how they both differently? 00:45:23.412 --> 00:45:24.120 align:middle line:90% JON GRUBER: Yeah. 00:45:24.120 --> 00:45:26.540 align:middle line:84% So the assignment problem is a technical problem, 00:45:26.540 --> 00:45:29.800 align:middle line:84% which is A, basically, it's hard to measure damage. 00:45:29.800 --> 00:45:33.640 align:middle line:84% And B, it's hard to compensate the losers, practically, 00:45:33.640 --> 00:45:35.440 align:middle line:90% when there's global warming. 00:45:35.440 --> 00:45:40.240 align:middle line:84% The holdout problem-- wait, which is the other one? 00:45:40.240 --> 00:45:41.297 align:middle line:90% AUDIENCE: Bargaining. 00:45:41.297 --> 00:45:42.880 align:middle line:84% JON GRUBER: Oh, the bargaining problem 00:45:42.880 --> 00:45:47.440 align:middle line:84% is that basically, it's related to the measurement. 00:45:47.440 --> 00:45:49.480 align:middle line:84% But it's also just that literally the conditions 00:45:49.480 --> 00:45:52.540 align:middle line:84% of bargaining get very tense and people don't act rationally. 00:45:52.540 --> 00:45:55.840 align:middle line:84% My $100 example, even if the fishermen-- even if it's $100, 00:45:55.840 --> 00:45:58.820 align:middle line:84% the steel plant may say to the fisherman, I'll give you $110. 00:45:58.820 --> 00:46:00.400 align:middle line:84% The fisherman might say yes to that. 00:46:00.400 --> 00:46:01.560 align:middle line:84% They may say, screw you, I hate you. 00:46:01.560 --> 00:46:02.935 align:middle line:84% You've poisoned my water forever. 00:46:02.935 --> 00:46:03.440 align:middle line:90% I want $150. 00:46:03.440 --> 00:46:04.180 align:middle line:90% I'm not doing it. 00:46:04.180 --> 00:46:04.760 align:middle line:90% OK? 00:46:04.760 --> 00:46:06.468 align:middle line:84% That's an example of bargaining problems. 00:46:06.468 --> 00:46:08.600 align:middle line:90% People are not Homo economicus. 00:46:08.600 --> 00:46:11.140 align:middle line:84% They don't behave hyper-rationally. 00:46:11.140 --> 00:46:11.700 align:middle line:90% Yeah. 00:46:11.700 --> 00:46:12.760 align:middle line:84% AUDIENCE: For the example for the holdout, 00:46:12.760 --> 00:46:15.540 align:middle line:84% that was when we had several steel plants along the river? 00:46:15.540 --> 00:46:17.980 align:middle line:84% JON GRUBER: No, the holdout example 00:46:17.980 --> 00:46:20.700 align:middle line:84% was basically when there are multiple fishermen, still 00:46:20.700 --> 00:46:21.720 align:middle line:90% one steel plant. 00:46:21.720 --> 00:46:24.340 align:middle line:84% There's multiple fishermen, and the holdout problem 00:46:24.340 --> 00:46:27.140 align:middle line:84% is the steel plant needs permission of every fisherman 00:46:27.140 --> 00:46:32.460 align:middle line:84% to pollute, and mean Enoch here won't give him permission. 00:46:32.460 --> 00:46:33.000 align:middle line:90% Yeah. 00:46:33.000 --> 00:46:35.667 align:middle line:84% AUDIENCE: Are there cases in the real world or markets, I guess, 00:46:35.667 --> 00:46:38.165 align:middle line:84% where the Coase theorem is like pseudo correct? 00:46:38.165 --> 00:46:39.040 align:middle line:90% JON GRUBER: Oh, yeah. 00:46:39.040 --> 00:46:40.928 align:middle line:90% No, this is a great question. 00:46:40.928 --> 00:46:43.220 align:middle line:84% When we teach these theorems, the Coase theorem, others 00:46:43.220 --> 00:46:45.060 align:middle line:84% we'll talk about, they definitely 00:46:45.060 --> 00:46:47.680 align:middle line:90% have directional effects. 00:46:47.680 --> 00:46:49.900 align:middle line:84% There are certainly times where there's 00:46:49.900 --> 00:46:52.580 align:middle line:84% private negotiations that can happen and can 00:46:52.580 --> 00:46:54.197 align:middle line:90% move you part of the way there. 00:46:54.197 --> 00:46:56.280 align:middle line:84% But the right way to think about the Coase theorem 00:46:56.280 --> 00:46:57.822 align:middle line:84% is, when's it going to work the best? 00:46:57.822 --> 00:47:01.260 align:middle line:84% When there's few parties, when information is transparent, 00:47:01.260 --> 00:47:04.020 align:middle line:84% and when they have a good relationship, then it can work. 00:47:04.020 --> 00:47:07.880 align:middle line:90% 00:47:07.880 --> 00:47:08.840 align:middle line:90% Yeah. 00:47:08.840 --> 00:47:10.920 align:middle line:90% Other questions? 00:47:10.920 --> 00:47:12.750 align:middle line:90% OK. 00:47:12.750 --> 00:47:16.360 align:middle line:84% So we've just answered the when question. 00:47:16.360 --> 00:47:18.400 align:middle line:84% When does the government intervene? 00:47:18.400 --> 00:47:20.840 align:middle line:90% When the private market fails. 00:47:20.840 --> 00:47:23.720 align:middle line:84% I've just shown you the private market fails. 00:47:23.720 --> 00:47:27.220 align:middle line:84% So now we have turned to the next question, which is, 00:47:27.220 --> 00:47:29.460 align:middle line:84% how might the government intervene? 00:47:29.460 --> 00:47:29.960 align:middle line:90% OK? 00:47:29.960 --> 00:47:32.127 align:middle line:84% We've answered the first question in public finance, 00:47:32.127 --> 00:47:33.640 align:middle line:84% when does the government intervene? 00:47:33.640 --> 00:47:35.520 align:middle line:84% Now we have to turn to the second question 00:47:35.520 --> 00:47:39.880 align:middle line:84% in public finance, which is, how might the government intervene? 00:47:39.880 --> 00:47:44.120 align:middle line:84% So now we're going to talk about public sector solutions 00:47:44.120 --> 00:47:45.380 align:middle line:90% to externalities. 00:47:45.380 --> 00:47:49.560 align:middle line:90% 00:47:49.560 --> 00:47:50.440 align:middle line:90% All right. 00:47:50.440 --> 00:47:54.170 align:middle line:84% Now, the first type of public sector solution we'll talk about 00:47:54.170 --> 00:47:57.070 align:middle line:84% is-- so now we're going to talk about public sector solution. 00:47:57.070 --> 00:47:59.517 align:middle line:90% 00:47:59.517 --> 00:48:01.850 align:middle line:84% So we're on the second question in public finance, which 00:48:01.850 --> 00:48:02.570 align:middle line:90% is the how. 00:48:02.570 --> 00:48:05.830 align:middle line:84% The first one we'll talk about is corrective taxation-- 00:48:05.830 --> 00:48:10.130 align:middle line:90% 00:48:10.130 --> 00:48:13.170 align:middle line:84% corrective taxation as a solution 00:48:13.170 --> 00:48:16.650 align:middle line:90% to negative externalities. 00:48:16.650 --> 00:48:18.770 align:middle line:84% How does corrective taxation work? 00:48:18.770 --> 00:48:22.130 align:middle line:90% Well, let's go to figure 5-6. 00:48:22.130 --> 00:48:27.370 align:middle line:84% Back to steel market, back to our sludge-producing steel guy. 00:48:27.370 --> 00:48:29.890 align:middle line:84% Once again, he wants to produce Q1. 00:48:29.890 --> 00:48:32.370 align:middle line:90% Society wants to produce Q2. 00:48:32.370 --> 00:48:33.930 align:middle line:90% He's going to overproduce. 00:48:33.930 --> 00:48:37.010 align:middle line:84% Coasian bargaining breaks down so he can't get it that way. 00:48:37.010 --> 00:48:40.490 align:middle line:84% What if we imposed a tax on him, which 00:48:40.490 --> 00:48:42.710 align:middle line:84% was exactly equal to the marginal damage he's doing, 00:48:42.710 --> 00:48:45.610 align:middle line:84% or $100 in the example I gave a few minutes ago? 00:48:45.610 --> 00:48:49.970 align:middle line:84% What if we imposed $100 tax per unit produced? 00:48:49.970 --> 00:48:52.430 align:middle line:84% Well, that would raise his marginal cost by $100 00:48:52.430 --> 00:48:55.248 align:middle line:84% and have the same effect of internalizing the externality. 00:48:55.248 --> 00:48:56.790 align:middle line:84% Not through the private market, which 00:48:56.790 --> 00:48:59.910 align:middle line:84% involves negotiation, but just through government fiat. 00:48:59.910 --> 00:49:02.390 align:middle line:84% We would say, you have to pay-- and once again, I'm 00:49:02.390 --> 00:49:05.070 align:middle line:84% assuming there's this linear damage. 00:49:05.070 --> 00:49:08.030 align:middle line:84% More complicated than the real world, and we'll get to that. 00:49:08.030 --> 00:49:10.230 align:middle line:84% We would say, look, you're doing this linear damage 00:49:10.230 --> 00:49:12.480 align:middle line:84% of $100 of a unit you produce, so I'm going to tax you 00:49:12.480 --> 00:49:14.630 align:middle line:90% $100 for every unit you produce. 00:49:14.630 --> 00:49:18.190 align:middle line:84% So that's going to create a new private marginal cost, which 00:49:18.190 --> 00:49:19.850 align:middle line:84% is equal to the social marginal cost. 00:49:19.850 --> 00:49:24.307 align:middle line:84% So PMC2 is equal to PMC1 plus the marginal damage. 00:49:24.307 --> 00:49:26.390 align:middle line:84% Essentially, if I want to produce a unit of steel, 00:49:26.390 --> 00:49:27.990 align:middle line:84% I got to pay all my workers, plus 00:49:27.990 --> 00:49:30.010 align:middle line:84% I now got to pay a tax to the government. 00:49:30.010 --> 00:49:31.910 align:middle line:84% And that government tax is set such 00:49:31.910 --> 00:49:35.150 align:middle line:84% that we end up at the optimal equilibrium. 00:49:35.150 --> 00:49:36.110 align:middle line:90% Done. 00:49:36.110 --> 00:49:38.222 align:middle line:84% It's like Coase, but the government is doing it, 00:49:38.222 --> 00:49:40.430 align:middle line:84% so you don't have to worry about assignment problems. 00:49:40.430 --> 00:49:42.710 align:middle line:84% All you have to worry about is measuring the externality 00:49:42.710 --> 00:49:43.377 align:middle line:90% and you're done. 00:49:43.377 --> 00:49:44.830 align:middle line:84% You measure the externality, boom. 00:49:44.830 --> 00:49:46.510 align:middle line:90% You set the tax. 00:49:46.510 --> 00:49:47.310 align:middle line:90% Yeah. 00:49:47.310 --> 00:49:49.630 align:middle line:84% AUDIENCE: So in the case of pollution, 00:49:49.630 --> 00:49:51.370 align:middle line:84% how is marginal damage even calculated? 00:49:51.370 --> 00:49:53.872 align:middle line:84% Is it based on how much everyone else emits too, 00:49:53.872 --> 00:49:55.330 align:middle line:84% or is it just based on [INAUDIBLE]? 00:49:55.330 --> 00:49:56.538 align:middle line:90% JON GRUBER: Awesome question. 00:49:56.538 --> 00:49:58.330 align:middle line:84% Calculating marginal damage is really-- 00:49:58.330 --> 00:49:59.790 align:middle line:90% that's very hard by itself. 00:49:59.790 --> 00:50:01.170 align:middle line:84% Now, of course, that doesn't make Coase any easier, 00:50:01.170 --> 00:50:03.010 align:middle line:84% because then you've got to put it in a private negotiating 00:50:03.010 --> 00:50:03.670 align:middle line:90% framework. 00:50:03.670 --> 00:50:05.150 align:middle line:90% But even this is not so easy. 00:50:05.150 --> 00:50:06.230 align:middle line:90% What's marginal damage? 00:50:06.230 --> 00:50:06.790 align:middle line:90% Is it linear? 00:50:06.790 --> 00:50:08.250 align:middle line:90% How do you measure it? 00:50:08.250 --> 00:50:11.610 align:middle line:84% I'm going to come to that in a little bit. 00:50:11.610 --> 00:50:14.590 align:middle line:84% Now, what about positive externalities? 00:50:14.590 --> 00:50:17.550 align:middle line:84% Well, there's an equivalent for positive externalities, 00:50:17.550 --> 00:50:19.410 align:middle line:90% which is a subsidy. 00:50:19.410 --> 00:50:22.170 align:middle line:90% Which is, you could just say-- 00:50:22.170 --> 00:50:25.490 align:middle line:84% in figure 5-7, we've got our R&D example. 00:50:25.490 --> 00:50:28.570 align:middle line:84% We can just say, look, firms are producing 00:50:28.570 --> 00:50:31.690 align:middle line:84% Q1 R&D. That's too little, because they're not 00:50:31.690 --> 00:50:35.530 align:middle line:84% accounting for the positive benefit on other firms 00:50:35.530 --> 00:50:37.330 align:middle line:90% for producing R&D. 00:50:37.330 --> 00:50:39.570 align:middle line:84% So we give them a subsidy, which is 00:50:39.570 --> 00:50:41.610 align:middle line:84% equal to the marginal benefit, which effectively 00:50:41.610 --> 00:50:44.130 align:middle line:84% lowers their private marginal cost, 00:50:44.130 --> 00:50:46.410 align:middle line:90% causes them to produce more. 00:50:46.410 --> 00:50:49.600 align:middle line:84% So it's like a tax raises their private marginal cost, 00:50:49.600 --> 00:50:51.260 align:middle line:90% causing them to produce less. 00:50:51.260 --> 00:50:53.760 align:middle line:84% A subsidy lowers their private marginal cost, 00:50:53.760 --> 00:50:56.580 align:middle line:84% causes them to produce more, and move into the optimal level 00:50:56.580 --> 00:50:58.980 align:middle line:90% of production of Q2. 00:50:58.980 --> 00:51:03.180 align:middle line:84% So this is using what we call the price mechanism. 00:51:03.180 --> 00:51:03.780 align:middle line:90% OK? 00:51:03.780 --> 00:51:05.420 align:middle line:84% A great example of the price mechanism 00:51:05.420 --> 00:51:07.128 align:middle line:84% in the real world that's been in the news 00:51:07.128 --> 00:51:10.765 align:middle line:84% lately is what we call congestion pricing. 00:51:10.765 --> 00:51:13.140 align:middle line:84% And you might have read-- this has been in the news a lot 00:51:13.140 --> 00:51:16.100 align:middle line:84% because of a debate in New York State. 00:51:16.100 --> 00:51:20.100 align:middle line:84% Economists since the dawn of time have said that, look, 00:51:20.100 --> 00:51:24.140 align:middle line:84% traffic is a classic negative externality. 00:51:24.140 --> 00:51:27.100 align:middle line:84% When you drive, you make my drive a little bit longer 00:51:27.100 --> 00:51:28.580 align:middle line:90% by clogging the road. 00:51:28.580 --> 00:51:31.340 align:middle line:84% The estimates are that the cost of traffic to the US, 00:51:31.340 --> 00:51:33.337 align:middle line:84% if you look at people's wasted time-- 00:51:33.337 --> 00:51:35.420 align:middle line:84% we'll talk about how we value time later-- is well 00:51:35.420 --> 00:51:37.780 align:middle line:90% over $100 billion a year. 00:51:37.780 --> 00:51:40.897 align:middle line:84% The idea is, well, that's an externality. 00:51:40.897 --> 00:51:43.480 align:middle line:84% By you driving, you're not only putting Bangladesh underwater. 00:51:43.480 --> 00:51:45.500 align:middle line:90% You're making my commute longer. 00:51:45.500 --> 00:51:49.700 align:middle line:84% So as a result, you should pay for that externality. 00:51:49.700 --> 00:51:52.600 align:middle line:84% You should pay for driving, in particular 00:51:52.600 --> 00:51:54.520 align:middle line:84% in areas where the traffic's bad or at times 00:51:54.520 --> 00:51:56.638 align:middle line:90% when the traffic's bad. 00:51:56.638 --> 00:51:58.180 align:middle line:84% Thus, the idea of congestion pricing. 00:51:58.180 --> 00:52:01.040 align:middle line:84% Congestion pricing has been used in Europe successfully in London 00:52:01.040 --> 00:52:02.360 align:middle line:90% and in Stockholm. 00:52:02.360 --> 00:52:04.300 align:middle line:84% In London, if you go into an inner city, 00:52:04.300 --> 00:52:08.120 align:middle line:84% into parts of London during certain hours, 00:52:08.120 --> 00:52:09.800 align:middle line:84% there is a fee that's imposed on you. 00:52:09.800 --> 00:52:12.880 align:middle line:84% You have your little electronic thing and they ping you. 00:52:12.880 --> 00:52:16.192 align:middle line:84% And they charge you a fee for driving in parts of London 00:52:16.192 --> 00:52:16.900 align:middle line:90% at certain hours. 00:52:16.900 --> 00:52:18.498 align:middle line:90% Same in Stockholm. 00:52:18.498 --> 00:52:20.540 align:middle line:84% These have been shown to be incredibly effective. 00:52:20.540 --> 00:52:23.240 align:middle line:84% They've lowered traffic, but not only 00:52:23.240 --> 00:52:25.500 align:middle line:90% that, they've improved health. 00:52:25.500 --> 00:52:26.000 align:middle line:90% Why? 00:52:26.000 --> 00:52:28.400 align:middle line:84% Well, first of all, there's fewer accidents. 00:52:28.400 --> 00:52:31.120 align:middle line:84% Second of all, there's less asthma among the kids 00:52:31.120 --> 00:52:33.440 align:middle line:84% because there's less car pollution in the cities. 00:52:33.440 --> 00:52:36.920 align:middle line:90% Pretty awesome indirect effect. 00:52:36.920 --> 00:52:39.720 align:middle line:84% Literally they're showing that kids' health improves 00:52:39.720 --> 00:52:42.640 align:middle line:84% with congestion pricing because there's 00:52:42.640 --> 00:52:44.920 align:middle line:84% less pollutants in the air and the kids are 00:52:44.920 --> 00:52:47.140 align:middle line:90% less likely to have asthma. 00:52:47.140 --> 00:52:52.565 align:middle line:84% Pretty awesome example of an unintended benefit. 00:52:52.565 --> 00:52:54.940 align:middle line:84% And of course, there's less greenhouse gas being emitted, 00:52:54.940 --> 00:52:57.980 align:middle line:84% which benefits all of us in terms of slowing global warming. 00:52:57.980 --> 00:53:02.303 align:middle line:84% Now, New York City had a mayor called Bloomberg. 00:53:02.303 --> 00:53:03.720 align:middle line:84% You might have heard of Bloomberg. 00:53:03.720 --> 00:53:05.300 align:middle line:84% Bloomberg is like Mr. Externalities. 00:53:05.300 --> 00:53:07.940 align:middle line:90% He totally loves this stuff. 00:53:07.940 --> 00:53:09.840 align:middle line:84% And he actually proposed congestion pricing. 00:53:09.840 --> 00:53:11.540 align:middle line:84% And after many decades, it actually 00:53:11.540 --> 00:53:13.865 align:middle line:90% made it through the debate. 00:53:13.865 --> 00:53:15.240 align:middle line:84% For years they wanted to pass it, 00:53:15.240 --> 00:53:16.657 align:middle line:84% and they couldn't get the support, 00:53:16.657 --> 00:53:17.920 align:middle line:90% because who wants a new tax? 00:53:17.920 --> 00:53:19.837 align:middle line:84% What they did is they did a very clever thing. 00:53:19.837 --> 00:53:21.740 align:middle line:84% They said, look, our subways are terrible. 00:53:21.740 --> 00:53:24.337 align:middle line:84% We'll take all the money from the congestion tax 00:53:24.337 --> 00:53:25.920 align:middle line:84% and put it into improving our subways. 00:53:25.920 --> 00:53:27.260 align:middle line:90% And it's a win-win. 00:53:27.260 --> 00:53:30.060 align:middle line:84% We get less driving and better subways. 00:53:30.060 --> 00:53:32.040 align:middle line:84% And it was almost going to be signed. 00:53:32.040 --> 00:53:33.620 align:middle line:84% And then the, I'm going to say it, 00:53:33.620 --> 00:53:36.980 align:middle line:84% cowardly governor of New York bagged it at the last minute 00:53:36.980 --> 00:53:39.180 align:middle line:84% because she was worried about the blowback, which 00:53:39.180 --> 00:53:40.640 align:middle line:90% is really, really unfortunate. 00:53:40.640 --> 00:53:43.940 align:middle line:84% This is a clear example of a win-win. 00:53:43.940 --> 00:53:46.270 align:middle line:84% But we see examples of this where there's policies 00:53:46.270 --> 00:53:50.270 align:middle line:84% that really only an economist could love don't often happen. 00:53:50.270 --> 00:53:52.030 align:middle line:84% And this is a classic thing where 00:53:52.030 --> 00:53:53.710 align:middle line:84% you've got a lot of opponents, people 00:53:53.710 --> 00:53:55.252 align:middle line:84% from my home state of New Jersey, who 00:53:55.252 --> 00:53:58.012 align:middle line:84% don't want to pay to commute into New York make a stink. 00:53:58.012 --> 00:53:58.970 align:middle line:90% And this gets canceled. 00:53:58.970 --> 00:54:00.150 align:middle line:90% So that's unfortunate. 00:54:00.150 --> 00:54:01.650 align:middle line:84% And hopefully New York will revert-- 00:54:01.650 --> 00:54:03.400 align:middle line:84% will see the error of its ways and reverse 00:54:03.400 --> 00:54:04.830 align:middle line:90% in putting congestion pricing. 00:54:04.830 --> 00:54:05.330 align:middle line:90% Yeah. 00:54:05.330 --> 00:54:07.830 align:middle line:84% AUDIENCE: Why did it need to go through the state government 00:54:07.830 --> 00:54:09.030 align:middle line:90% and not just city level? 00:54:09.030 --> 00:54:11.250 align:middle line:84% JON GRUBER: I don't know the logistics of the New York law, 00:54:11.250 --> 00:54:13.083 align:middle line:84% but for some reason the governor had a veto. 00:54:13.083 --> 00:54:14.267 align:middle line:90% The legislature passed it. 00:54:14.267 --> 00:54:15.850 align:middle line:84% Somebody had to go to the state level. 00:54:15.850 --> 00:54:16.510 align:middle line:90% And I don't quite know. 00:54:16.510 --> 00:54:19.350 align:middle line:84% Maybe because it's inter-state, because people from New Jersey 00:54:19.350 --> 00:54:20.390 align:middle line:90% would pay it. 00:54:20.390 --> 00:54:21.550 align:middle line:90% I don't know. 00:54:21.550 --> 00:54:23.610 align:middle line:90% Good question. 00:54:23.610 --> 00:54:24.390 align:middle line:90% All right. 00:54:24.390 --> 00:54:28.370 align:middle line:84% So now, you might be thinking to yourself, well, 00:54:28.370 --> 00:54:30.310 align:middle line:84% this is all interesting, kind of cool. 00:54:30.310 --> 00:54:35.150 align:middle line:84% But if we want Q2, why don't we just say, produce Q2. 00:54:35.150 --> 00:54:37.130 align:middle line:90% Why don't we just regulate? 00:54:37.130 --> 00:54:41.270 align:middle line:90% 00:54:41.270 --> 00:54:44.490 align:middle line:84% That is, instead of using a corrective tax or the price 00:54:44.490 --> 00:54:46.950 align:middle line:84% mechanism, why don't we just regulate? 00:54:46.950 --> 00:54:52.930 align:middle line:84% That is, if you go back to figure 5-6, 00:54:52.930 --> 00:54:55.323 align:middle line:84% we could put in this convoluted tax and measure. 00:54:55.323 --> 00:54:57.490 align:middle line:84% Someone said figure out what the marginal damage is. 00:54:57.490 --> 00:54:59.790 align:middle line:84% We say look, Q2 is what you should produce. 00:54:59.790 --> 00:55:01.650 align:middle line:90% Produce Q2, done. 00:55:01.650 --> 00:55:03.770 align:middle line:84% None of this fancy economic stuff, 00:55:03.770 --> 00:55:08.490 align:middle line:84% none of this politics over taxes, just say produce Q2 00:55:08.490 --> 00:55:10.330 align:middle line:90% and we're done. 00:55:10.330 --> 00:55:17.410 align:middle line:84% And in fact, that would have a very similar impact. 00:55:17.410 --> 00:55:21.550 align:middle line:84% If you just did Q2, you'd be done with it. 00:55:21.550 --> 00:55:25.330 align:middle line:84% And in fact, that is the approach we've typically 00:55:25.330 --> 00:55:27.770 align:middle line:84% taken in environmental regulation in the US 00:55:27.770 --> 00:55:31.490 align:middle line:84% historically, has been quantity regulation, 00:55:31.490 --> 00:55:34.795 align:middle line:84% what's often called command and control regulation. 00:55:34.795 --> 00:55:36.170 align:middle line:84% Which you just said, look, you're 00:55:36.170 --> 00:55:37.650 align:middle line:90% producing too many pollutants. 00:55:37.650 --> 00:55:39.610 align:middle line:90% Produce less, boom. 00:55:39.610 --> 00:55:41.650 align:middle line:90% Full stop. 00:55:41.650 --> 00:55:46.070 align:middle line:84% So what we want to turn to next after one detour is 00:55:46.070 --> 00:55:48.710 align:middle line:84% talking about why would you use price 00:55:48.710 --> 00:55:51.390 align:middle line:90% versus quantity regulation? 00:55:51.390 --> 00:55:54.510 align:middle line:90% When would they make sense? 00:55:54.510 --> 00:55:57.310 align:middle line:84% Now, to do so, we need a new framework. 00:55:57.310 --> 00:55:59.830 align:middle line:84% Before we do so, I want to talk about one other thing 00:55:59.830 --> 00:56:04.070 align:middle line:84% that is very important as a historical lesson, which 00:56:04.070 --> 00:56:06.390 align:middle line:84% is we talked about corrective subsidies. 00:56:06.390 --> 00:56:07.890 align:middle line:84% We talked about corrective subsidies 00:56:07.890 --> 00:56:11.230 align:middle line:84% when you have underproduction, say underproduction of R&D. 00:56:11.230 --> 00:56:13.750 align:middle line:84% And there's no better example of the power 00:56:13.750 --> 00:56:18.670 align:middle line:84% of corrective subsidies than Operation Warp Speed. 00:56:18.670 --> 00:56:24.030 align:middle line:84% Now, when COVID came along, we realized we needed a vaccine. 00:56:24.030 --> 00:56:30.590 align:middle line:84% Vaccines are a classic example of a positive production 00:56:30.590 --> 00:56:31.530 align:middle line:90% externality. 00:56:31.530 --> 00:56:32.830 align:middle line:90% And why is that? 00:56:32.830 --> 00:56:35.390 align:middle line:84% That's because they're often not very profitable, 00:56:35.390 --> 00:56:38.190 align:middle line:84% or the profits are highly uncertain. 00:56:38.190 --> 00:56:41.040 align:middle line:84% Take, for example, the vaccine that 00:56:41.040 --> 00:56:46.920 align:middle line:84% was going to be developed for Ebola. 00:56:46.920 --> 00:56:50.280 align:middle line:84% Ebola struck West Africa in 2013. 00:56:50.280 --> 00:56:53.073 align:middle line:84% Immediately began to work on a vaccine for Ebola. 00:56:53.073 --> 00:56:55.240 align:middle line:84% It took them six years to make it, which is actually 00:56:55.240 --> 00:56:57.392 align:middle line:90% very fast in vaccine time. 00:56:57.392 --> 00:56:59.100 align:middle line:84% And by the time they did, Ebola was gone. 00:56:59.100 --> 00:57:00.400 align:middle line:90% No one wanted it. 00:57:00.400 --> 00:57:04.360 align:middle line:84% They'd invested billions into making this vaccine 00:57:04.360 --> 00:57:05.500 align:middle line:90% and it just got wasted. 00:57:05.500 --> 00:57:06.920 align:middle line:90% No one wanted the vaccine. 00:57:06.920 --> 00:57:08.940 align:middle line:84% So companies don't invest in vaccines. 00:57:08.940 --> 00:57:11.023 align:middle line:84% You invent a cancer drug, you know cancer is still 00:57:11.023 --> 00:57:12.400 align:middle line:90% going to be there in six years. 00:57:12.400 --> 00:57:14.288 align:middle line:84% Vaccines, people aren't sure if the demand 00:57:14.288 --> 00:57:16.580 align:middle line:84% is going to be there, if people are going to want them. 00:57:16.580 --> 00:57:18.720 align:middle line:84% So there's massive under-investment in vaccines. 00:57:18.720 --> 00:57:21.360 align:middle line:84% So what did the government do when COVID came along? 00:57:21.360 --> 00:57:23.020 align:middle line:84% They set up Operation Warp Speed. 00:57:23.020 --> 00:57:24.920 align:middle line:84% The Trump administration, to their credit, 00:57:24.920 --> 00:57:26.640 align:middle line:90% set up Operation Warp Speed. 00:57:26.640 --> 00:57:29.480 align:middle line:84% What this did was two kinds of subsidies, 00:57:29.480 --> 00:57:31.600 align:middle line:90% we call them push and pull. 00:57:31.600 --> 00:57:38.640 align:middle line:84% The push incentive was the kind that we have in figure 5-7, 00:57:38.640 --> 00:57:41.540 align:middle line:84% which is literally we subsidized R&D. 00:57:41.540 --> 00:57:47.020 align:middle line:84% We gave billions of dollars to companies to do R&D 00:57:47.020 --> 00:57:49.468 align:middle line:90% into vaccines. 00:57:49.468 --> 00:57:51.760 align:middle line:84% The second, which is not really depicted on this graph, 00:57:51.760 --> 00:57:53.620 align:middle line:84% is what we call a pull incentive. 00:57:53.620 --> 00:57:57.060 align:middle line:84% The pull incentive was we guaranteed, no matter what 00:57:57.060 --> 00:57:58.660 align:middle line:90% happened, we would buy them. 00:57:58.660 --> 00:58:00.780 align:middle line:84% The government said, even if COVID goes away, 00:58:00.780 --> 00:58:03.500 align:middle line:84% we guarantee we'll buy a billion doses. 00:58:03.500 --> 00:58:08.260 align:middle line:84% So we've taken the uncertainty out of your decision. 00:58:08.260 --> 00:58:10.720 align:middle line:84% Due to those two incentives, the COVID vaccine, 00:58:10.720 --> 00:58:13.200 align:middle line:84% which all experts predicted would take 10 years, 00:58:13.200 --> 00:58:15.260 align:middle line:90% took 10 months. 00:58:15.260 --> 00:58:17.020 align:middle line:90% It's unbelievable. 00:58:17.020 --> 00:58:21.220 align:middle line:84% It's truly a modern miracle how fast we got the COVID vaccine. 00:58:21.220 --> 00:58:23.580 align:middle line:84% It's all a blur in the rear view mirror. 00:58:23.580 --> 00:58:26.012 align:middle line:84% But if you were talking to people like me 00:58:26.012 --> 00:58:28.720 align:middle line:84% early in the COVID, I would have said, well look, if we're lucky, 00:58:28.720 --> 00:58:30.340 align:middle line:84% we'll get it in five or six years. 00:58:30.340 --> 00:58:33.620 align:middle line:84% The notion of doing it in 10 months is just beyond belief. 00:58:33.620 --> 00:58:35.697 align:middle line:84% And the vaccines probably have saved-- 00:58:35.697 --> 00:58:38.030 align:middle line:84% the best estimates are two million lives have been saved 00:58:38.030 --> 00:58:40.470 align:middle line:90% worldwide by the COVID vaccine. 00:58:40.470 --> 00:58:41.450 align:middle line:90% It's amazing. 00:58:41.450 --> 00:58:43.542 align:middle line:84% And if we didn't have anti-vax movements 00:58:43.542 --> 00:58:45.250 align:middle line:84% of the kind we discussed a bit last time, 00:58:45.250 --> 00:58:46.630 align:middle line:90% it would be even higher. 00:58:46.630 --> 00:58:49.670 align:middle line:84% So basically, this is a classic example 00:58:49.670 --> 00:58:53.670 align:middle line:84% of the power of corrective subsidies. 00:58:53.670 --> 00:58:56.270 align:middle line:84% Now, that detour aside, let's go back 00:58:56.270 --> 00:59:01.070 align:middle line:84% and talk about how do we think about quantity versus price 00:59:01.070 --> 00:59:03.690 align:middle line:84% approaches to correcting externalities? 00:59:03.690 --> 00:59:06.470 align:middle line:84% And to do so, I'm going to have to freak you out a little bit 00:59:06.470 --> 00:59:08.070 align:middle line:90% and switch the framework. 00:59:08.070 --> 00:59:13.350 align:middle line:84% So we're now going to move to a framework like figure 5-8. 00:59:13.350 --> 00:59:16.330 align:middle line:84% In figure 5-8, we're going to change the example. 00:59:16.330 --> 00:59:19.350 align:middle line:84% In the previous example, the only way 00:59:19.350 --> 00:59:23.830 align:middle line:84% that I could pollute less was by producing less steel. 00:59:23.830 --> 00:59:25.042 align:middle line:90% But of course that's wrong. 00:59:25.042 --> 00:59:26.250 align:middle line:90% I can do other things, right? 00:59:26.250 --> 00:59:29.610 align:middle line:84% I could put a grill over-- just picture the Lorax. 00:59:29.610 --> 00:59:31.550 align:middle line:84% How many of you guys have read The Lorax? 00:59:31.550 --> 00:59:33.300 align:middle line:84% You can picture Lorax speak for the trees. 00:59:33.300 --> 00:59:35.592 align:middle line:84% You could see the plant and stuff dumping in the river. 00:59:35.592 --> 00:59:36.808 align:middle line:90% I could put a grill over it. 00:59:36.808 --> 00:59:39.350 align:middle line:84% Or I could do something which actually reduces the pollution. 00:59:39.350 --> 00:59:42.130 align:middle line:84% I wouldn't have to actually slow my production of steel. 00:59:42.130 --> 00:59:43.550 align:middle line:90% So that's a more realistic case. 00:59:43.550 --> 00:59:48.010 align:middle line:84% And that more realistic case is depicted in figure 5-8. 00:59:48.010 --> 00:59:52.017 align:middle line:84% In figure 5-8, we have the market for pollution reduction. 00:59:52.017 --> 00:59:53.850 align:middle line:84% It's a weird market, because usually markets 00:59:53.850 --> 00:59:55.470 align:middle line:90% are for positive things. 00:59:55.470 --> 00:59:57.190 align:middle line:84% There's a market for pollution reduction. 00:59:57.190 --> 00:59:58.232 align:middle line:90% What do you mean by that? 00:59:58.232 --> 01:00:02.910 align:middle line:84% On the x-axis is the amount of pollution reduction a firm does. 01:00:02.910 --> 01:00:05.130 align:middle line:84% So as you move to the right, the firm 01:00:05.130 --> 01:00:07.530 align:middle line:84% is doing more pollution reduction. 01:00:07.530 --> 01:00:12.815 align:middle line:84% As you move to the left, the firm has more pollution. 01:00:12.815 --> 01:00:14.190 align:middle line:84% So to the left is more pollution, 01:00:14.190 --> 01:00:17.050 align:middle line:84% to the right is more pollution reduction. 01:00:17.050 --> 01:00:17.810 align:middle line:90% OK? 01:00:17.810 --> 01:00:20.150 align:middle line:84% On the y-axis it's just dollars, costs and benefits. 01:00:20.150 --> 01:00:22.010 align:middle line:90% We'll come back to that. 01:00:22.010 --> 01:00:25.670 align:middle line:84% So in other words, if you look at-- 01:00:25.670 --> 01:00:27.730 align:middle line:84% we talked about an example where there 01:00:27.730 --> 01:00:32.690 align:middle line:84% was a constant marginal damage done by pollution. 01:00:32.690 --> 01:00:36.870 align:middle line:84% Well, in this framework, that becomes the marginal benefit 01:00:36.870 --> 01:00:39.270 align:middle line:90% of pollution reduction. 01:00:39.270 --> 01:00:42.030 align:middle line:84% The marginal damage done by pollution 01:00:42.030 --> 01:00:44.530 align:middle line:84% is the marginal benefit of pollution reduction. 01:00:44.530 --> 01:00:46.430 align:middle line:84% For every unit of pollution you reduce, 01:00:46.430 --> 01:00:49.270 align:middle line:90% you save $100 worth of fish. 01:00:49.270 --> 01:00:55.093 align:middle line:84% So that red line is the benefit of pollution reduction, 01:00:55.093 --> 01:00:57.010 align:middle line:84% the marginal benefit, every unit of pollution. 01:00:57.010 --> 01:00:58.635 align:middle line:84% And once again, I've assumed it's flat. 01:00:58.635 --> 01:01:00.070 align:middle line:90% It doesn't have to be. 01:01:00.070 --> 01:01:02.230 align:middle line:90% That's the benefit. 01:01:02.230 --> 01:01:05.470 align:middle line:84% What is the marginal cost of pollution reduction? 01:01:05.470 --> 01:01:08.310 align:middle line:84% OK, well, here I'm going to make an assumption. 01:01:08.310 --> 01:01:12.230 align:middle line:84% I'm going to assume that the more pollution reduction you do, 01:01:12.230 --> 01:01:14.890 align:middle line:84% the more expensive it is per unit to do it. 01:01:14.890 --> 01:01:16.050 align:middle line:90% This is sort of intuitive. 01:01:16.050 --> 01:01:17.210 align:middle line:84% When you're doing sludge removal, 01:01:17.210 --> 01:01:19.710 align:middle line:84% it's pretty inexpensive to just put a grate over the pipe 01:01:19.710 --> 01:01:21.890 align:middle line:84% and you maybe cut your pollution by 20%. 01:01:21.890 --> 01:01:22.432 align:middle line:90% That's cheap. 01:01:22.432 --> 01:01:24.640 align:middle line:84% But if you want the pollution all the way to nothing, 01:01:24.640 --> 01:01:27.270 align:middle line:84% you've got to change the entire power plant and production 01:01:27.270 --> 01:01:28.010 align:middle line:90% process. 01:01:28.010 --> 01:01:29.510 align:middle line:90% That's expensive. 01:01:29.510 --> 01:01:32.710 align:middle line:84% So what we assume is that the marginal cost of pollution 01:01:32.710 --> 01:01:35.060 align:middle line:90% reduction is rising. 01:01:35.060 --> 01:01:37.320 align:middle line:84% An assumption, but a sensible one. 01:01:37.320 --> 01:01:39.260 align:middle line:84% So at zero pollution reduction at point A, 01:01:39.260 --> 01:01:40.840 align:middle line:90% there's zero marginal cost. 01:01:40.840 --> 01:01:43.820 align:middle line:84% As you reduce pollution more, the blue line-- 01:01:43.820 --> 01:01:45.700 align:middle line:90% which is pollution reduction. 01:01:45.700 --> 01:01:48.200 align:middle line:84% And that's the private marginal cost of pollution reduction. 01:01:48.200 --> 01:01:50.020 align:middle line:84% We'll also assume it's the social marginal cost, 01:01:50.020 --> 01:01:52.395 align:middle line:84% that there's no externalities in the market for pollution 01:01:52.395 --> 01:01:53.000 align:middle line:90% reduction. 01:01:53.000 --> 01:01:57.040 align:middle line:84% So we're going to call this the social marginal cost 01:01:57.040 --> 01:01:59.200 align:middle line:84% of pollution reduction is the blue curve 01:01:59.200 --> 01:02:01.880 align:middle line:84% and the social marginal benefit of pollution reduction 01:02:01.880 --> 01:02:03.960 align:middle line:90% is the red curve. 01:02:03.960 --> 01:02:08.720 align:middle line:84% So now let's ask, what is the privately optimal amount 01:02:08.720 --> 01:02:10.120 align:middle line:90% of pollution reduction? 01:02:10.120 --> 01:02:12.880 align:middle line:84% Well, the privately optimal pollution reduction 01:02:12.880 --> 01:02:16.000 align:middle line:84% is where the private marginal benefit of pollution reduction 01:02:16.000 --> 01:02:17.460 align:middle line:84% equals the private marginal cost. 01:02:17.460 --> 01:02:18.680 align:middle line:90% Where is that? 01:02:18.680 --> 01:02:21.180 align:middle line:84% What is the private marginal benefit of pollution reduction? 01:02:21.180 --> 01:02:23.020 align:middle line:84% Someone raise their hand and tell me. 01:02:23.020 --> 01:02:23.520 align:middle line:90% Yeah. 01:02:23.520 --> 01:02:24.145 align:middle line:90% AUDIENCE: Zero. 01:02:24.145 --> 01:02:24.960 align:middle line:90% JON GRUBER: Zero. 01:02:24.960 --> 01:02:27.732 align:middle line:84% So the private optimum is at A. That's 01:02:27.732 --> 01:02:29.440 align:middle line:84% where the private marginal benefit equals 01:02:29.440 --> 01:02:30.380 align:middle line:90% the private marginal cost. 01:02:30.380 --> 01:02:31.500 align:middle line:84% They don't do any pollution reduction. 01:02:31.500 --> 01:02:31.900 align:middle line:90% Why should they? 01:02:31.900 --> 01:02:33.620 align:middle line:84% They don't care about the fishermen. 01:02:33.620 --> 01:02:38.020 align:middle line:84% But the social optimum is where the social marginal benefit 01:02:38.020 --> 01:02:42.180 align:middle line:84% equals the private and social cost, which is at point B. 01:02:42.180 --> 01:02:47.460 align:middle line:84% So the social optimum is R star of reduction or P 01:02:47.460 --> 01:02:49.100 align:middle line:90% star of pollution. 01:02:49.100 --> 01:02:51.380 align:middle line:90% That's the social optimum. 01:02:51.380 --> 01:02:54.200 align:middle line:84% So it's the same logic as before. 01:02:54.200 --> 01:02:55.980 align:middle line:84% We've just changed what we're looking at 01:02:55.980 --> 01:02:58.320 align:middle line:84% to have the more realistic case of pollution reduction. 01:02:58.320 --> 01:03:00.080 align:middle line:84% We don't really talk about we talk about pollution. 01:03:00.080 --> 01:03:00.940 align:middle line:84% You want to be looking to steal or you 01:03:00.940 --> 01:03:02.732 align:middle line:84% want to look at pollution reduction market. 01:03:02.732 --> 01:03:04.180 align:middle line:84% That's what we're looking at here. 01:03:04.180 --> 01:03:05.733 align:middle line:90% OK, questions about that? 01:03:05.733 --> 01:03:07.400 align:middle line:84% I realize I've changed things up on you. 01:03:07.400 --> 01:03:07.900 align:middle line:90% Yeah. 01:03:07.900 --> 01:03:10.100 align:middle line:84% AUDIENCE: Is the social marginal benefit flat 01:03:10.100 --> 01:03:12.480 align:middle line:84% just because it's in that specific example? 01:03:12.480 --> 01:03:16.060 align:middle line:84% JON GRUBER: In that specific example, I've assumed it's flat. 01:03:16.060 --> 01:03:19.140 align:middle line:84% I guess next time I'll get to examples where it's not flat. 01:03:19.140 --> 01:03:24.140 align:middle line:90% Now, in this case-- 01:03:24.140 --> 01:03:25.380 align:middle line:90% yeah, I'm sorry. 01:03:25.380 --> 01:03:28.580 align:middle line:84% AUDIENCE: Yeah, why is the social marginal benefit-- 01:03:28.580 --> 01:03:31.160 align:middle line:84% why does it not intersect the marginal cost 01:03:31.160 --> 01:03:35.233 align:middle line:90% curve as high as possible? 01:03:35.233 --> 01:03:36.900 align:middle line:84% JON GRUBER: Oh, that's a great question. 01:03:36.900 --> 01:03:40.188 align:middle line:84% So in other words, why is the red line not higher? 01:03:40.188 --> 01:03:42.480 align:middle line:84% Well, the red line is not higher because that literally 01:03:42.480 --> 01:03:44.120 align:middle line:90% is the social marginal benefit. 01:03:44.120 --> 01:03:45.323 align:middle line:90% So in other words-- 01:03:45.323 --> 01:03:47.740 align:middle line:84% actually, that's a great segue to what I want to say next. 01:03:47.740 --> 01:03:49.323 align:middle line:84% I'll answer your question in a second. 01:03:49.323 --> 01:03:52.200 align:middle line:84% I want you to contrast two approaches to government policy 01:03:52.200 --> 01:03:53.720 align:middle line:90% in this diagram. 01:03:53.720 --> 01:03:55.520 align:middle line:90% One approach is regulation. 01:03:55.520 --> 01:03:59.440 align:middle line:84% Regulation would say, look, tell them they got to produce R star. 01:03:59.440 --> 01:04:01.240 align:middle line:90% Done, easy. 01:04:01.240 --> 01:04:05.240 align:middle line:90% The other is a tax. 01:04:05.240 --> 01:04:10.520 align:middle line:90% Imagine I set the tax at $50. 01:04:10.520 --> 01:04:13.920 align:middle line:84% Imagine I said that firms had to pay 01:04:13.920 --> 01:04:20.040 align:middle line:84% a tax of $50 for every unit of pollution that made. 01:04:20.040 --> 01:04:24.280 align:middle line:84% They would choose a point between A and B, 01:04:24.280 --> 01:04:25.880 align:middle line:84% because the marginal cost-- they would 01:04:25.880 --> 01:04:28.005 align:middle line:84% choose a point where the marginal cost of pollution 01:04:28.005 --> 01:04:28.700 align:middle line:90% reduction is 50. 01:04:28.700 --> 01:04:31.210 align:middle line:84% If pollution reduction was less than 50, they'd do it. 01:04:31.210 --> 01:04:32.710 align:middle line:84% But if it's more than 50, why do it? 01:04:32.710 --> 01:04:34.770 align:middle line:90% They'll just pay the tax. 01:04:34.770 --> 01:04:37.730 align:middle line:90% Now let's come to this question. 01:04:37.730 --> 01:04:39.850 align:middle line:90% The actual cost is 100. 01:04:39.850 --> 01:04:43.770 align:middle line:90% Why do I not set the tax at 500? 01:04:43.770 --> 01:04:45.970 align:middle line:84% Why am I only setting the tax at 100? 01:04:45.970 --> 01:04:48.790 align:middle line:84% Look, why not just say, look, pollution is bad. 01:04:48.790 --> 01:04:50.210 align:middle line:90% Set the tax of 500. 01:04:50.210 --> 01:04:51.210 align:middle line:90% Why is that not optimal? 01:04:51.210 --> 01:04:52.960 align:middle line:84% That's a sort of version of your question. 01:04:52.960 --> 01:04:54.317 align:middle line:90% Why is that not optimal? 01:04:54.317 --> 01:04:56.150 align:middle line:84% AUDIENCE: Because then they'll produce less, 01:04:56.150 --> 01:04:56.890 align:middle line:90% and it will be inefficient. 01:04:56.890 --> 01:04:58.682 align:middle line:84% JON GRUBER: Because you're missing the fact 01:04:58.682 --> 01:05:00.450 align:middle line:90% that steel is valuable. 01:05:00.450 --> 01:05:06.210 align:middle line:84% And pollution should almost never be zero. 01:05:06.210 --> 01:05:09.250 align:middle line:84% This is the thing that has been a slowly-learned lesson 01:05:09.250 --> 01:05:11.450 align:middle line:90% by environmentalists over time. 01:05:11.450 --> 01:05:13.450 align:middle line:84% I'll talk more about this next time. 01:05:13.450 --> 01:05:16.510 align:middle line:84% But pollution should almost never be zero. 01:05:16.510 --> 01:05:18.950 align:middle line:84% And we could make pollution zero today. 01:05:18.950 --> 01:05:19.450 align:middle line:90% OK? 01:05:19.450 --> 01:05:23.810 align:middle line:84% No lights, no heat, no cars, no production. 01:05:23.810 --> 01:05:25.330 align:middle line:90% Pollution zero. 01:05:25.330 --> 01:05:28.470 align:middle line:84% That isn't optimal, because we derive value 01:05:28.470 --> 01:05:30.750 align:middle line:90% from lights and heat and cars. 01:05:30.750 --> 01:05:32.950 align:middle line:84% You only want to tax them to the extent 01:05:32.950 --> 01:05:35.110 align:middle line:90% it's causing external damage. 01:05:35.110 --> 01:05:36.710 align:middle line:84% And that's why the red line-- that's 01:05:36.710 --> 01:05:38.290 align:middle line:84% why you want it fair for the external damage. 01:05:38.290 --> 01:05:39.650 align:middle line:90% And that sets the optimal tax. 01:05:39.650 --> 01:05:41.730 align:middle line:84% If you set the tax at 100-- one second-- 01:05:41.730 --> 01:05:44.090 align:middle line:84% if you set the tax at 100, what do you get? 01:05:44.090 --> 01:05:45.790 align:middle line:84% You get the same thing as you get 01:05:45.790 --> 01:05:48.390 align:middle line:84% from the quantity regulation, reduction of R star. 01:05:48.390 --> 01:05:49.590 align:middle line:90% Question. 01:05:49.590 --> 01:05:54.430 align:middle line:84% AUDIENCE: So if you get into [INAUDIBLE] quantities, 01:05:54.430 --> 01:05:59.990 align:middle line:84% which is a decision between going from another thing-- 01:05:59.990 --> 01:06:01.653 align:middle line:90% deciding whether you want to-- 01:06:01.653 --> 01:06:02.570 align:middle line:90% JON GRUBER: OK, great. 01:06:02.570 --> 01:06:04.170 align:middle line:84% So that's the question I want to ask. 01:06:04.170 --> 01:06:06.170 align:middle line:84% That's the question-- I've just showed you first 01:06:06.170 --> 01:06:09.190 align:middle line:84% how in this simple example they're the same. 01:06:09.190 --> 01:06:13.390 align:middle line:84% Now, let's talk about why they might not be the same. 01:06:13.390 --> 01:06:17.870 align:middle line:84% Let's move to an example with two firms. 01:06:17.870 --> 01:06:19.135 align:middle line:90% Figure 5-9 is complicated. 01:06:19.135 --> 01:06:20.510 align:middle line:84% So let's walk through it together 01:06:20.510 --> 01:06:23.310 align:middle line:90% and ask me questions OK. 01:06:23.310 --> 01:06:31.610 align:middle line:84% We have two firms, A and B. The difference is that firm A has-- 01:06:31.610 --> 01:06:35.610 align:middle line:84% the difference is that they have different cost curves. 01:06:35.610 --> 01:06:43.290 align:middle line:84% OK, firm A has a higher marginal cost of reduction than firm B. 01:06:43.290 --> 01:06:48.870 align:middle line:84% So firm B, to reduce by 50 units, costs them 100. 01:06:48.870 --> 01:06:52.090 align:middle line:84% That's a point X. Firm A is a lower 01:06:52.090 --> 01:06:53.970 align:middle line:90% marginal cost of reduction. 01:06:53.970 --> 01:06:55.470 align:middle line:84% Lower marginal cost of reduction. 01:06:55.470 --> 01:06:57.930 align:middle line:84% Firm A is more efficient at reducing. 01:06:57.930 --> 01:07:02.530 align:middle line:84% So they, for, $100 can get rid of 150 units. 01:07:02.530 --> 01:07:06.370 align:middle line:84% Firm B at a cost of $100 can only get rid of 50 units. 01:07:06.370 --> 01:07:07.530 align:middle line:90% Do you see that? 01:07:07.530 --> 01:07:09.070 align:middle line:84% So look at the marginal cost curves. 01:07:09.070 --> 01:07:12.240 align:middle line:84% Firm A's marginal cost curve is to the right. 01:07:12.240 --> 01:07:14.490 align:middle line:84% It is a more efficient-- in other words, the other way 01:07:14.490 --> 01:07:17.650 align:middle line:84% to think about this is literally firm A can reduce pollution 01:07:17.650 --> 01:07:20.510 align:middle line:90% by 50 for nothing. 01:07:20.510 --> 01:07:23.550 align:middle line:90% Their X-intercept is at 50. 01:07:23.550 --> 01:07:29.820 align:middle line:84% So firm A is a more efficient pollution reducer. 01:07:29.820 --> 01:07:34.620 align:middle line:84% Now, let's say that we decide the optimal pollution 01:07:34.620 --> 01:07:36.160 align:middle line:90% reduction is 200. 01:07:36.160 --> 01:07:38.500 align:middle line:84% Let's say we start in a world where there 01:07:38.500 --> 01:07:43.252 align:middle line:90% is 400 units of pollution. 01:07:43.252 --> 01:07:46.880 align:middle line:84% With no government intervention, you get 400 units of pollution. 01:07:46.880 --> 01:07:48.660 align:middle line:84% Let's say that's our starting point. 01:07:48.660 --> 01:07:51.700 align:middle line:84% And let's say that we decide that the optimum-- so that's 01:07:51.700 --> 01:07:54.140 align:middle line:90% the private, that's Q1. 01:07:54.140 --> 01:07:57.660 align:middle line:84% We decide the optimal amount of pollution is 200. 01:07:57.660 --> 01:08:00.180 align:middle line:90% So that's P1 is 400. 01:08:00.180 --> 01:08:05.040 align:middle line:84% P2 or the optimum we decide is 200. 01:08:05.040 --> 01:08:07.240 align:middle line:84% So we want to reduce pollution by 200. 01:08:07.240 --> 01:08:09.660 align:middle line:90% We want a reduction of 200. 01:08:09.660 --> 01:08:11.700 align:middle line:84% Once again, stop me when this isn't clear. 01:08:11.700 --> 01:08:12.200 align:middle line:90% OK? 01:08:12.200 --> 01:08:14.340 align:middle line:90% Want a reduction of 200. 01:08:14.340 --> 01:08:16.439 align:middle line:90% How do we do that? 01:08:16.439 --> 01:08:16.939 align:middle line:90% Yeah. 01:08:16.939 --> 01:08:19.168 align:middle line:84% AUDIENCE: Is that point Z on this graph? 01:08:19.168 --> 01:08:20.960 align:middle line:84% JON GRUBER: I haven't gotten to points yet. 01:08:20.960 --> 01:08:22.293 align:middle line:90% I'm just giving you the example. 01:08:22.293 --> 01:08:24.399 align:middle line:90% OK, how can we do that? 01:08:24.399 --> 01:08:27.240 align:middle line:84% Well, one example is we can say, well, look, 01:08:27.240 --> 01:08:30.420 align:middle line:84% we know we want a reduction of 200. 01:08:30.420 --> 01:08:31.540 align:middle line:90% There's two firms. 01:08:31.540 --> 01:08:34.760 align:middle line:90% Let's make them each do 100. 01:08:34.760 --> 01:08:36.420 align:middle line:84% That would be the quantity approach. 01:08:36.420 --> 01:08:38.760 align:middle line:84% We know we've got 200 to reduce, two firms. 01:08:38.760 --> 01:08:40.720 align:middle line:90% Let's make them each do 100. 01:08:40.720 --> 01:08:42.479 align:middle line:90% What would that result in? 01:08:42.479 --> 01:08:48.240 align:middle line:84% Well, that would result in firms ending up at the points MCA, 100 01:08:48.240 --> 01:08:51.840 align:middle line:90% and MCB, 100. 01:08:51.840 --> 01:08:54.000 align:middle line:84% If firm B has to reduce by 100, they 01:08:54.000 --> 01:08:57.200 align:middle line:84% end up at the point MCB, 100, with a very high cost 01:08:57.200 --> 01:08:58.960 align:middle line:90% of pollution reduction. 01:08:58.960 --> 01:09:01.499 align:middle line:84% Firm A ends up at MCA, 100 with a low cost 01:09:01.499 --> 01:09:04.240 align:middle line:90% of pollution reduction. 01:09:04.240 --> 01:09:07.580 align:middle line:90% Why is that inefficient? 01:09:07.580 --> 01:09:08.080 align:middle line:90% Yeah. 01:09:08.080 --> 01:09:12.000 align:middle line:84% AUDIENCE: Because firm A should be producing more. 01:09:12.000 --> 01:09:13.520 align:middle line:90% JON GRUBER: Yeah, firm A can-- 01:09:13.520 --> 01:09:16.180 align:middle line:84% this is inefficient because firm A is better at this. 01:09:16.180 --> 01:09:19.319 align:middle line:90% So they should do more of it. 01:09:19.319 --> 01:09:23.380 align:middle line:84% So here, the quantity regulation doesn't give you 01:09:23.380 --> 01:09:25.180 align:middle line:90% the best outcome. 01:09:25.180 --> 01:09:28.140 align:middle line:84% Compare that to price regulation. 01:09:28.140 --> 01:09:34.460 align:middle line:84% Imagine we said that we are going to charge-- 01:09:34.460 --> 01:09:41.340 align:middle line:84% we are going to charge firms $100 for every unit of pollution 01:09:41.340 --> 01:09:44.420 align:middle line:90% they produce. 01:09:44.420 --> 01:09:45.020 align:middle line:90% OK? 01:09:45.020 --> 01:09:46.800 align:middle line:90% We're going to charge them $100. 01:09:46.800 --> 01:09:52.460 align:middle line:84% Well, in that case, firm B will say, look, at $100, 01:09:52.460 --> 01:09:56.460 align:middle line:84% I'm going to reduce by the amount X, 50 units. 01:09:56.460 --> 01:09:57.752 align:middle line:90% Why am I going to do that? 01:09:57.752 --> 01:09:59.460 align:middle line:84% This comes to the question here about why 01:09:59.460 --> 01:10:00.980 align:middle line:90% it's the red line, not the top. 01:10:00.980 --> 01:10:04.920 align:middle line:84% Because if it's above 50 units, it costs more than $100. 01:10:04.920 --> 01:10:07.620 align:middle line:90% I'll just pay the damn fine. 01:10:07.620 --> 01:10:10.980 align:middle line:84% Below 50 units, I want to reduce. 01:10:10.980 --> 01:10:14.500 align:middle line:84% Firm A says, I'll reduce 150 units. 01:10:14.500 --> 01:10:15.140 align:middle line:90% Why? 01:10:15.140 --> 01:10:17.098 align:middle line:84% Because that's where their marginal cost equals 01:10:17.098 --> 01:10:18.180 align:middle line:90% the marginal benefit. 01:10:18.180 --> 01:10:20.360 align:middle line:84% Guess what-- that is up to 200 units. 01:10:20.360 --> 01:10:21.910 align:middle line:90% You're done. 01:10:21.910 --> 01:10:25.510 align:middle line:84% So by setting the tax-- and that is efficient. 01:10:25.510 --> 01:10:28.430 align:middle line:84% That's efficient because every firm is spending the same amount 01:10:28.430 --> 01:10:30.457 align:middle line:90% to reduce pollution. 01:10:30.457 --> 01:10:32.290 align:middle line:84% Once again, we're forgetting redistribution. 01:10:32.290 --> 01:10:34.130 align:middle line:84% And I'm not talking about A better than B. 01:10:34.130 --> 01:10:35.870 align:middle line:90% It's all about efficiency. 01:10:35.870 --> 01:10:38.590 align:middle line:84% The efficient outcome is where every firm 01:10:38.590 --> 01:10:42.230 align:middle line:84% is paying the same marginal cost of reduction. 01:10:42.230 --> 01:10:44.130 align:middle line:90% And you get that with the tax. 01:10:44.130 --> 01:10:48.910 align:middle line:84% You don't get that with the crude quantity regulation. 01:10:48.910 --> 01:10:54.670 align:middle line:84% Unless-- how could I solve the quantity regulation problem? 01:10:54.670 --> 01:10:55.970 align:middle line:90% You know the answer. 01:10:55.970 --> 01:10:57.150 align:middle line:90% AUDIENCE: Cap and trade. 01:10:57.150 --> 01:10:58.870 align:middle line:90% JON GRUBER: You could trade. 01:10:58.870 --> 01:11:01.350 align:middle line:90% So now let's get really funky. 01:11:01.350 --> 01:11:05.770 align:middle line:84% Let's say that I say I want to reduce pollution by 200, 01:11:05.770 --> 01:11:07.630 align:middle line:90% but I don't care who does it. 01:11:07.630 --> 01:11:09.870 align:middle line:84% I know I want to reduce it by 200, 01:11:09.870 --> 01:11:11.590 align:middle line:90% but I don't care who does it. 01:11:11.590 --> 01:11:12.330 align:middle line:90% How do I do that? 01:11:12.330 --> 01:11:17.350 align:middle line:84% Well, what I do is I say, look, firm A and B, 01:11:17.350 --> 01:11:23.530 align:middle line:84% I'm going to give each of you 100 permits for pollution. 01:11:23.530 --> 01:11:29.250 align:middle line:84% At the end of the day, any pollution you do which you 01:11:29.250 --> 01:11:33.050 align:middle line:84% cannot hand me a permit for you will pay-- 01:11:33.050 --> 01:11:33.730 align:middle line:90% I'm sorry. 01:11:33.730 --> 01:11:35.050 align:middle line:90% Yes. 01:11:35.050 --> 01:11:35.830 align:middle line:90% Let me go back. 01:11:35.830 --> 01:11:38.890 align:middle line:84% You can only do the amount of pollution you have permits for. 01:11:38.890 --> 01:11:41.090 align:middle line:84% So I'm issuing 200 permits because that's 01:11:41.090 --> 01:11:43.090 align:middle line:90% the optimal amount of pollution. 01:11:43.090 --> 01:11:44.310 align:middle line:90% I can give them away any way. 01:11:44.310 --> 01:11:46.810 align:middle line:84% I'm assuming I split them 50/50, but that doesn't have to be 01:11:46.810 --> 01:11:47.792 align:middle line:90% true. 01:11:47.792 --> 01:11:49.500 align:middle line:84% We'll talk more about this next time, how 01:11:49.500 --> 01:11:51.170 align:middle line:90% this was proposed in practice. 01:11:51.170 --> 01:11:54.010 align:middle line:90% So I have 200 pollution permits. 01:11:54.010 --> 01:11:57.170 align:middle line:84% I'm going to give them away, say, 50/50, each get 100. 01:11:57.170 --> 01:12:00.250 align:middle line:84% And I'm going to say, you guys can trade them if you want. 01:12:00.250 --> 01:12:01.410 align:middle line:90% What happens there? 01:12:01.410 --> 01:12:04.050 align:middle line:84% Well, our starting point is they don't trade. 01:12:04.050 --> 01:12:08.430 align:middle line:84% If they don't trade, they each can only pollute 100 units. 01:12:08.430 --> 01:12:11.930 align:middle line:84% And you end up back at MCB and MCA. 01:12:11.930 --> 01:12:13.792 align:middle line:84% Now, at that point, what should happen? 01:12:13.792 --> 01:12:15.250 align:middle line:84% Well, at that point, B should go to 01:12:15.250 --> 01:12:20.310 align:middle line:84% and say you know what, I'll buy your permit, because look, 01:12:20.310 --> 01:12:23.330 align:middle line:84% it's only costing you like $50 to reduce at that point. 01:12:23.330 --> 01:12:25.670 align:middle line:90% It's costing me like $200. 01:12:25.670 --> 01:12:29.630 align:middle line:84% So as long as I can buy your permit for between 50 and 200, 01:12:29.630 --> 01:12:31.130 align:middle line:84% you should be happy to sell it to me 01:12:31.130 --> 01:12:33.150 align:middle line:90% and I should be happy to buy it. 01:12:33.150 --> 01:12:34.790 align:middle line:90% So I'll buy that permit. 01:12:34.790 --> 01:12:36.990 align:middle line:84% In fact, I'll keep buying permits 01:12:36.990 --> 01:12:41.470 align:middle line:84% until we end up at X and Y, because every point between MCA 01:12:41.470 --> 01:12:43.070 align:middle line:84% and MCB, every point other than that, 01:12:43.070 --> 01:12:46.710 align:middle line:84% there's an efficiency gain from selling permits. 01:12:46.710 --> 01:12:49.630 align:middle line:84% And we'll continue until the equilibrium price of permits 01:12:49.630 --> 01:12:52.070 align:middle line:90% is $100. 01:12:52.070 --> 01:12:56.070 align:middle line:84% So you'll replicate the tax outcome through trading. 01:12:56.070 --> 01:12:59.870 align:middle line:84% Now, once again, that assumes that the trading 01:12:59.870 --> 01:13:02.090 align:middle line:84% doesn't break down for all these various reasons. 01:13:02.090 --> 01:13:04.150 align:middle line:84% We're back in the private market problems. 01:13:04.150 --> 01:13:09.218 align:middle line:84% Firm A could hate firm B. The government has 01:13:09.218 --> 01:13:10.510 align:middle line:90% to assign the value, et cetera. 01:13:10.510 --> 01:13:11.730 align:middle line:90% There's lots of problems. 01:13:11.730 --> 01:13:14.950 align:middle line:84% But in principle, you could get to that outcome with a quantity 01:13:14.950 --> 01:13:17.480 align:middle line:90% regulation and cap and trade. 01:13:17.480 --> 01:13:20.000 align:middle line:84% But we're already starting to see the reason why 01:13:20.000 --> 01:13:24.600 align:middle line:84% economists tend to prefer price solutions to quantity solutions. 01:13:24.600 --> 01:13:27.960 align:middle line:84% They tend to prefer price solutions for two reasons. 01:13:27.960 --> 01:13:31.240 align:middle line:84% First of all, you need to add an extra step to the quantity 01:13:31.240 --> 01:13:34.360 align:middle line:84% solution to be as efficient as the price solution. 01:13:34.360 --> 01:13:37.000 align:middle line:84% Second of all, you need a lot more information. 01:13:37.000 --> 01:13:41.600 align:middle line:90% Let's go back to figure 5-6. 01:13:41.600 --> 01:13:44.920 align:middle line:90% 01:13:44.920 --> 01:13:48.560 align:middle line:84% Now, here I said I could either tax you by the amount MD 01:13:48.560 --> 01:13:51.640 align:middle line:90% or I could impose Q2. 01:13:51.640 --> 01:13:55.460 align:middle line:84% What do I need to know for the tax? 01:13:55.460 --> 01:13:56.880 align:middle line:90% I need to know one thing. 01:13:56.880 --> 01:13:59.160 align:middle line:90% What's the marginal damage? 01:13:59.160 --> 01:14:01.480 align:middle line:84% What do I need to know for the optimal regulation? 01:14:01.480 --> 01:14:03.140 align:middle line:84% I need to know the marginal damage. 01:14:03.140 --> 01:14:04.348 align:middle line:90% I need to know demand curves. 01:14:04.348 --> 01:14:05.720 align:middle line:90% I need to know supply curves. 01:14:05.720 --> 01:14:09.680 align:middle line:84% I need to know a ton more stuff that's super hard to measure. 01:14:09.680 --> 01:14:12.660 align:middle line:84% So taxes basically have a lower information requirement. 01:14:12.660 --> 01:14:16.160 align:middle line:84% Now, once again, easy in this case where damage is flat. 01:14:16.160 --> 01:14:19.600 align:middle line:84% But as long as damage is locally flat, or you can approximate it, 01:14:19.600 --> 01:14:21.312 align:middle line:84% you need to know a lot less for a tax 01:14:21.312 --> 01:14:22.520 align:middle line:90% than you do for a regulation. 01:14:22.520 --> 01:14:23.940 align:middle line:84% For regulation, I got to know everything 01:14:23.940 --> 01:14:25.700 align:middle line:84% that's involved in finding point B. That means 01:14:25.700 --> 01:14:27.117 align:middle line:84% I got to know demand curve, supply 01:14:27.117 --> 01:14:28.540 align:middle line:90% curves, and marginal damage. 01:14:28.540 --> 01:14:31.300 align:middle line:84% For tax, I just need to know marginal damage and I'm done. 01:14:31.300 --> 01:14:33.900 align:middle line:84% So taxes have two big advantages. 01:14:33.900 --> 01:14:35.640 align:middle line:84% There's an informational advantage-- 01:14:35.640 --> 01:14:37.660 align:middle line:90% you need to know less. 01:14:37.660 --> 01:14:41.260 align:middle line:84% And there is a heterogeneous firms advantage 01:14:41.260 --> 01:14:44.100 align:middle line:84% which is that by pricing the externality, 01:14:44.100 --> 01:14:47.180 align:middle line:84% you get firms to do what's in their best interest. 01:14:47.180 --> 01:14:50.482 align:middle line:84% You get firms to efficiently reduce pollution. 01:14:50.482 --> 01:14:51.440 align:middle line:90% This is very important. 01:14:51.440 --> 01:14:53.180 align:middle line:84% And the question that was asked here about the red line 01:14:53.180 --> 01:14:55.060 align:middle line:84% not being at the top is so important, 01:14:55.060 --> 01:14:59.420 align:middle line:84% because this exactly traces the intellectual history 01:14:59.420 --> 01:15:00.820 align:middle line:90% of this type of approach. 01:15:00.820 --> 01:15:03.500 align:middle line:84% Which is when permits were first-- when people first 01:15:03.500 --> 01:15:05.860 align:middle line:84% started talking about using taxes or cap and trade, 01:15:05.860 --> 01:15:08.160 align:middle line:84% it was dramatically opposed, indeed, 01:15:08.160 --> 01:15:09.827 align:middle line:90% in almost religious terms. 01:15:09.827 --> 01:15:11.660 align:middle line:84% Many of you that know your religious history 01:15:11.660 --> 01:15:14.208 align:middle line:84% and will know what led to the downfall of the Catholic Church 01:15:14.208 --> 01:15:16.000 align:middle line:84% was in the Middle Ages, the Catholic Church 01:15:16.000 --> 01:15:17.975 align:middle line:90% used to sell absolutions. 01:15:17.975 --> 01:15:19.600 align:middle line:84% So the way it worked was, if you sinned 01:15:19.600 --> 01:15:21.760 align:middle line:84% you went to hell, unless you gave the Catholic 01:15:21.760 --> 01:15:23.560 align:middle line:90% Church a piece of gold. 01:15:23.560 --> 01:15:26.200 align:middle line:84% And they gave you a paper that said you won't go to hell. 01:15:26.200 --> 01:15:30.000 align:middle line:84% This was viewed as not super appropriate. 01:15:30.000 --> 01:15:32.420 align:middle line:84% And Martin Luther decided to fight against it. 01:15:32.420 --> 01:15:35.240 align:middle line:84% And that led to the birth of Protestantism. 01:15:35.240 --> 01:15:37.680 align:middle line:84% Many people referred to cap and trade systems 01:15:37.680 --> 01:15:40.080 align:middle line:90% as pollution absolution. 01:15:40.080 --> 01:15:43.520 align:middle line:84% They said it is wrong to allow firms to buy their way out 01:15:43.520 --> 01:15:44.100 align:middle line:90% of polluting. 01:15:44.100 --> 01:15:46.000 align:middle line:90% Look, what is cap and trade? 01:15:46.000 --> 01:15:48.295 align:middle line:84% Firm B is buying their way out of polluting. 01:15:48.295 --> 01:15:50.920 align:middle line:84% They're saying, I'm still going to pollute and just pay for it. 01:15:50.920 --> 01:15:52.760 align:middle line:84% And people say it's ethically wrong. 01:15:52.760 --> 01:15:54.280 align:middle line:90% And they were wrong. 01:15:54.280 --> 01:15:58.000 align:middle line:84% It's ethically fine because all we really care about 01:15:58.000 --> 01:16:01.160 align:middle line:84% is the damage done to society by the pollution. 01:16:01.160 --> 01:16:03.240 align:middle line:84% Now, you may say there are reasons 01:16:03.240 --> 01:16:06.560 align:middle line:84% why some firms should pay more and some firms should pay less. 01:16:06.560 --> 01:16:07.940 align:middle line:90% And we get into that. 01:16:07.940 --> 01:16:12.880 align:middle line:84% But the bottom line is, if you want to reduce pollution, 01:16:12.880 --> 01:16:15.590 align:middle line:84% you want to reduce it in the most efficient way. 01:16:15.590 --> 01:16:17.090 align:middle line:84% Let me just leave you with one story 01:16:17.090 --> 01:16:19.237 align:middle line:90% to illustrate this, which is-- 01:16:19.237 --> 01:16:21.570 align:middle line:84% I'll talk next time about negotiating the Global Warming 01:16:21.570 --> 01:16:21.870 align:middle line:90% Treaty. 01:16:21.870 --> 01:16:23.690 align:middle line:84% I was at Kyoto in 1992 when they negotiated 01:16:23.690 --> 01:16:25.610 align:middle line:84% the original global warming treaty. 01:16:25.610 --> 01:16:30.998 align:middle line:84% And at that meeting in Kyoto, the liberals from the US 01:16:30.998 --> 01:16:33.290 align:middle line:84% were very much in favor of these kinds of cap and trade 01:16:33.290 --> 01:16:34.065 align:middle line:90% solutions. 01:16:34.065 --> 01:16:36.690 align:middle line:84% And I said, gee, I thought you environmentalists kind of didn't 01:16:36.690 --> 01:16:38.232 align:middle line:84% like this pollution absolution stuff. 01:16:38.232 --> 01:16:40.250 align:middle line:84% And they said, no, actually, we've 01:16:40.250 --> 01:16:44.510 align:middle line:84% realized that it's efficient to regulate in this way. 01:16:44.510 --> 01:16:47.770 align:middle line:84% And the more efficient we can regulate, the more we can do. 01:16:47.770 --> 01:16:51.170 align:middle line:84% So their view was everybody wins when you regulate efficiently. 01:16:51.170 --> 01:16:53.550 align:middle line:84% You don't just allow efficient production. 01:16:53.550 --> 01:16:55.550 align:middle line:84% But by making regulation less painful, 01:16:55.550 --> 01:16:58.170 align:middle line:84% you allow the government to do more of it. 01:16:58.170 --> 01:17:00.477 align:middle line:90% OK, so let me stop there. 01:17:00.477 --> 01:17:02.810 align:middle line:84% We'll come back next time to talk about the last section 01:17:02.810 --> 01:17:03.755 align:middle line:90% of chapter 5. 01:17:03.755 --> 01:17:05.130 align:middle line:84% And then we'll start on chapter 6 01:17:05.130 --> 01:17:08.360 align:middle line:84% and talk about environmental externalities in practice. 01:17:08.360 --> 01:17:13.000 align:middle line:90%