1: Jacob: I'm Jacob Clifford

2: Adriene: and I'm Adriene Hill and welcome to Crash Course Economics.

4: Jacob: In the last few videos we've said a lot of nice things about how competitive

8: markets allocate resources. You know, they do a pretty good job.

11: Adriene: But nobody's perfect. Sometimes markets get it wrong. Sometimes they fail.

16: Sometimes the byproducts of production make people sick. Today we are going to talk about

21: those market failures, and how economists address them.

24: [Theme Music]

33: In 2105, a story made the rounds online about a University of Maryland professor and an

39: extra credit question: "Select whether you want 2 points or 6 points added onto your

45: final paper grade. But there's a small catch...if more than 10% of the class selects 6 points,

51: then no one gets any points." So, what would you do? Personal Incentives

54: The question alludes to one of the biggest problems with free markets: sometimes people

59: have a personal incentive to do something that is against the collective interests of

63: the group. Obviously, everyone wants at least some extra credit, but there is also an incentive

69: to get even more points. In this situation, the professor reported that too many people

74: chose 6 points and no one got extra credit.

77: Let's say that your local government sent a similar proposition to every household in

82: your city, “Select whether you want to pay $20 or $100 to fund the local fire department,

88: but there's a small catch: if more than 50% of citizens choose $20 there's not going

94: to be enough money to have a fire department.” Free Riders

96: This is the free rider problem. Free riders are people who benefit without paying. They

101: are not necessarily evil, let's face it, you probably know someone that's illegally

105: downloaded Game of Thrones, but they're responding to incentives -- why pay more, if I can get it for less?

112: If too many people think like this, then we're all worse off and we're going to end up not

116: getting the things we want like fire protection or a satisfying ending to Game of Thrones.

121: So how do most cities get around the problem that some people will benefit even if they

126: don't pay. The city doesn't ask for money, they demand money in the form of taxes. The

131: reasoning is that fire protection is so essential that people shouldn't be allowed to opt out.

137: Jacob: So things that are for our collective well being, like fire protection, schools,

140: and national defense are often funded by the government. When markets alone fail to provide

144: enough of these things, that's called market failures. These are often called public goods,

149: but the technical definition of a public good is anything that has two characteristics:

153: non-exclusion and non-rivalry. Non-exclusion is the idea that you can't exclude people

157: that don't pay. For example, it's impossible to limit the benefits of national defense

161: to only people that pay their taxes. People who pay no federal taxes still get the benefit

165: of protection from bombs, and people who pay a lot of federal taxes don't get extra protection.

169: Non-rivalry is the idea that one person's consumption of the good doesn't ruin it

173: for other people. So, public parks are a great example. You can use it today, I can use it

177: tomorrow; it can be shared. Ideally.

179: If a good or service meets these two criteria it's unlikely that private firms will produce

183: it, no matter how essential it is. Street lights and organizations that track and prevent the spread of

188: diseases are pretty important, and if the government doesn't step in, we probably won't get them. Tragedy of the Commons

192: Adriene: The incentive to do what's best for you, rather than what's best for everyone

196: is the root cause of something economists call the Tragedy of the Commons. This is the

202: idea that common goods that everyone has access to are often misused and exploited. It explains

209: the cause of most of our environmental problems like air pollution, deforestation, the killing

214: of endangered species, and overfishing.

216: In many places in the world, there are more fish being pulled out of rivers, lakes, and

220: oceans than are being born. This is not just bad for the fish; it's bad for the people

226: doing the fishing. As these resources are depleted, fishermen find themselves without a job.

231: So why aren't they conserving? Allowing fish to reproduce and generate more fish resources

237: for the future? Well, look at the incentives. If a few environmentally conscious fishermen

242: decide to give the fish time to spawn, then some other fisherman will harvest them instead.

248: If you can't prevent other people from exploiting the resource, then you have an incentive to

253: exploit it yourself and take as much as you can, as quickly as you can.

257: But, with everyone following that logic, the finite resource gets pillaged. The Tragedy

263: of the Commons explains why fish stocks get depleted, the rainforest get cut down, and

268: why endangered species get hunted for their hides or horns. There is an entire subfield

274: of economics focused on address and solving these issues, it is called environmental economics.

279: Jacob: The problem here is that unregulated markets sometimes don't produce the outcome

282: that society wants. Remember, sometimes markets misallocate resources because they don't have

287: the right price signals. There is no better example of this than what economists call

291: externalities. Externalities are situations when there's an external costs or external

294: benefits that accrue to other people or society as a whole. When other people are made worse

299: off that's called a negative externality. When other people are made better off

302: that's called a positive externality. Let's go to the Thought Bubble.

304: Let's look at a TV factory that pollutes a river with toxic chemicals. This is definitely

308: a negative externality. The factory has internal costs: it has to pay its workers, buy raw

313: materials, pay for energy; and it uses those costs to determine how many TVs to produce.

317: But there are also external costs associated with polluting the waterways, like dead fish,

321: contaminated drinking water, and people getting sick. Those external costs are paid by people

326: downstream, and they are likely to be ignored by the factory owner. The free market assumes

330: that all the costs associated with producing TVs are accounted for within the price of

334: those TVs, but, in this case, the market is wrong. The end result is a market failure

339: because the factory is producing too many TVs.

341: As for positive externalities. Think of education. More education is great for you.

345: You'll likely generate more income and it makes you more interesting to talk to at parties.

349: But there are also external benefits of your education. Everyone is actually made better off.

354: With more education you're more likely be a positive and productive member of society.

357: And if you earn a higher income, that means more tax revenue.

360: Now in both cases, negative and positive externalities, economists often look to the government to

365: step in and solve the problem. For example, the government could tax the TV factory or

368: subsidize education. In fact, externalities are the justification for almost everything

373: the government does. When politicians, tax cigarettes, fund education, subsidize fuel

377: efficient cars, or regulate financial markets, it's because they are convinced that free

381: markets alone are not adjusting for externalities.

383: Adriene: Thanks Thought Bubble. We've tried to explain the problem of externalities, now Regulatory Policies

387: let's talk about the solutions. When the government tries to fix externalities they

392: can use regulatory policies or market-based policies.

395: Regulatory policies are simply rules established by government decree. Some people complain

401: about regulation. They say, “the government can't tell me what to do.” But let's be

405: honest, it can. The government also spends a ton of time and money telling you what you

410: can't do. Don't drive too fast. Don't build a house in Yellowstone. Don't kill anybody. Regulation

415: It seems like the government probably should regulate some stuff. The question is, “how

420: much should they regulate?” Even people who adamantly oppose government regulation

425: probably agree that nuclear weapons and nerve gas shouldn't be on the shelves at Target.

429: Let's go back to the TV factory example. To help solve the pollution externality, the

434: government could ban the use of certain types of chemicals or set a production quota to

439: limit the production of TVs or regulate what can be dumped in the river. In the US, the

445: Environmental Protection Agency (EPA) has pushed for laws to control pollution, and

449: these regulations have worked.

451: Regulation can also create positive externalities. In some cases, the external benefits are perceived

457: to be so high that the government essentially takes over the market. Consider education.

463: Most countries have compulsory education which requires citizens to be educated up to a specific

469: age and the government pays for schools through taxes.

472: If the government didn't get involved, all education would be provided by private schools

477: that would charge tuition; there might not be enough affordable schools to educate young

481: people. The government funds education because they think that the external benefits, like MarketBased Policies

486: literate, well-informed, erudite citizens, are so high it's worth forcing everyone to pay.

492: Jacob: Another way that governments try to solve externalities is with market-based policies.

497: These are policies designed to manipulate markets, prices, and incentives to correct

501: for market failures. The best examples are taxes and subsidies. A tax on the production

505: of TVs or on the chemicals the factory is using will decrease production and limit pollution.

510: Federal grants that help subsidize college education will increase the amount of education people buy.

515: In general, economists tend to prefer market-based policies. Take cigarettes. Cigarettes generate

519: high external costs on society. There's second hand smoke and there's higher healthcare costs

523: for everyone, due to smoking related illnesses.

525: The government could force cigarettes companies to produce less, or just shut them down entirely,

529: but instead they tax cigarettes. The tax drives up the price, consumers buy fewer cigarettes,

533: and this addresses the negative externality. Now, this market-based approach has one key

537: advantage over the regulatory approach. Instead of spending money on enforcing regulations,

542: the government is earning tax revenue that can be used for purposes. In real life, though,

546: governments often use both policies. In the US, the government taxes cigarette producers

550: and regulates where people can smoke. It also restricts how tobacco companies can advertise,

554: and supports anti-smoking campaigns designed to convince people to quit smoking.

558: Seriously, you should stop smoking.

559: Market-based approaches to reduce negative externalities are also used to fight climate

563: change. Many economists argue that taxes on carbon-based fuels like coal, oil, and gas

568: are a more effective way to deal with air pollution.

570: Adriene: One oft-discussed market-based policy is emissions trading or “cap and trade.”

575: The government issues pollution permits and if your factory doesn't hold one of those

578: permits, it can't pollute. But companies can buy or sell those permits.

583: This sets up incentives to go green: if you can produce without pollution, you can make

586: money by selling your permits. But if you operate a dirty plant, you have to pay for

591: those extra permits. As controversial as cap and trade can be among American politicians, Cap and Trade

597: it's interesting to note that it's already been used successfully in the US.

601: A cap and trade program to reduce acid rain pollution -- it worked! It cut sulfur dioxide

607: emissions. According to a 2003 report from the Office of Management and Budget, “the

613: Acid Rain Program accounted for the largest quantified human health benefits of any major

619: federal regulatory program implemented in the last 10 years, with benefits exceeding

625: costs by more than 40:1.”

627: Remember that extra credit question? What if the world's largest economies were given

632: a similar proposition: “Select whether you want to decrease your pollution by 5% or 30%,

639: with a small catch; if more than 50% of counties choose only 5% then climate change will make Earth unlivable." Conclusion

647: That simplifies the issue, but it does illustrate why it's so hard to address climate change.

653: Individual countries might work to reduce carbon dioxide emissions, but they can't

658: prevent other countries from polluting. It's the Tragedy of the Commons.

662: In an unregulated global economy, where producers want to make products as cheaply as possible,

668: there's an incentive to ignore international environment to get ahead. Global issues like

672: climate change, human rights abuses, and nuclear proliferation can't be effectively addressed

678: if countries don't work together. But that requires a lot of trust and a lot of commitment.

683: Jacob: So markets aren't perfect. There are many cases when the government should get

686: involved, and there's even some situations when the government should just take control.

690: Adriene: The question isn't “which is better: free markets or government?” The

694: question is “how can they work together to make our lives better?”

697: Thanks for watching, we'll see you next week.

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