How Did Economists Blow It (Part 2)? – They Missed The Negative Externalities of America’s Limited Liability Society
by ilene - September 9th, 2009 12:41 am
How Did Economists Blow It (Part 2)? – They Missed The Negative Externalities of America’s Limited Liability Society
Courtesy of Mark Sunshine’s Sunshine Report
Paul Krugman’s New York Times Magazine article of September 6th maintains that externalities are the most important factor in market failures, but then never considers whether or not large “externalities” caused the failures of 2007. By ignoring externalities, the usually brilliant Mr. Krugman illustrates why economists didn’t see the market crash and Great Recession. The unintended and unrecognized effects of negative externalities were probably the largest factor that contributed to the summer of 2007crash, yet economists virtually ignore these cultural and sociological phenomena that almost resulted in economic seppuku.
Mr. Krugman wrote a single sentence about externalities when he said “…economists admitted that there were cases in which markets might fail, of which the most important was the case of “externalities” – costs that people impose on others without paying the price, like traffic congestion or pollution.”
According to Wikipedia (which has a pretty good article on externalities): “In economics, an externality or spillover of an economic transaction is an impact on a party that is not directly involved in the transaction. In such a case, prices do not reflect the full costs…of production…or a product or services…In a competitive market, the existence of externalities would cause either too much or too little of the good to be produced or consumed…If there exists external costs such as pollution, the good will be overproduced by a competitive market, as the producer does not take into account the external costs when producing the good…economics has shown that the existence of externalities result in outcomes that are not socially optimal.”
A good web site for first year economics students, Tutor2u also has a description of externalities. “Externalities are common in virtually every area of economic activity. They are defined as third party (of spill-over) effects arising from the production and/or consumption of goods and services for which no appropriate compensation is paid…Externalities can cause market failure if the price mechanism does not take into account the full social costs and social benefits of production and consumption…This leads to the private optimum output being greater than the social optimum level of production. “
A little bit of translation is needed at this point. Bubbles are characterized
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
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