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 .

The fountain of youth: Pomegranates and the Demand Curve

A nice example to use with a basic Demand Curve lesson.

Two of the Determinants of Demand are a "change in consumer tastes/expectations" and "change in the number of buyers".  This article suggests research shows pomegranates have some anti-ageing properties:

"...The humble pomegranate may old the secret to a long and healthy life. 
Scientists say the Middle Eastern fruit contains a ‘miracle’ ingredient that strengthens ageing muscles and extends life. 
With experiments in worms and mice producing results that ‘are nothing sort of amazing’, they are now testing the fountain of youth supplement on people. 
Even something as simple as keeping muscles young could reduce the number of falls among the elderly and increase independence, allowing people to live in their own homes for longer. 
The Swiss scientists said: ‘We believe this research is a milestone in anti-ageing efforts.’ 
Their excitement centres on the pomegranate’s ability to keep mitochondria, the tiny 'battery packs' that power our cells, charged up...."---The Daily Mail

This new information, once widely disseminated, will likely have an impact on the current market for pomegranates.

The current market for pomegranates has a specific price ("Pe") and market quantity demanded ("Qe").  See graph:

With this new finding it seems reasonable that at that same price a higher/larger quantity demanded ("Q1") will emerge as people who previously were not interested in pomegranates become intrigued by this potential fountain of youth:

Ceteris Paribus, what happens at "Pe" and "Q1" will also happen at ALL other points along the "Demand*".  Without plotting those additional points, we can intuitively see a new Demand Curve is created that lies wholly to the RIGHT of the previous one.
Note: the impetus for the change in demand was NOT the price for pomegranates.  The price stayed the same but a larger quantity was demanded at that price because something OTHER than the price occurred in the market for pomegranates ("miracle fruit!).

Subsequently there will likely be a change in price which in turn WILL affect the Quantity Demanded until we reach a new equilibrium price.

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