Tuesday, July 19, 2016

Negative Externality Example: The cost of methane damage to the environment.

This graphic comes from a study I found on the National Bureau of Economic Research (NBER) website.  It is a study that suggests producers and consumers of natural gas do not cover the "true cost" of delivering natural gas for consumption.  The concern is the climate unfriendly methane from the gas that is lost to the environment through unrepaired and/or neglected pipelines.

These "external costs" (Blue Bar) are not borne by producers nor consumers of natural gas but none the less are imposed on society in the form of environmental degradation.  

If those costs were internalized within in the market, then the cost of producing natural gas would be considerably higher.  This would be reflected in a Supply Curve that includes the private cost of producing AND the social costs as well.

The result would be a product that has a market price that is higher and a market quantity that is less than the market would produce.

Below are a series of graphs that illustrate "what SHOULD be" (the "Socially Optimal") in terms of the market outcome if those external costs were internalized in the market.

Because those costs in "real life" are not internalized, then the market creates "Dead Weight Loss"---a quantity of the good that is produced where the marginal cost is greater than the marginal benefit, as noted by the price consumers are willing to pay. This is denoted by the Red Triangle in that last slide .

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