Pretty much since the beginning of the automobile industry, lead had been blended with gasoline in order to boost octane levels. Lead content before regulation was 2-3 grams per gallon. Due to EPA regulations in 1973, lead content was phased down to 0.1 grams per gallon by 1986.
State governments are now starting to set manufacturing requirements regarding the minimum efficiency of light bulbs produced. One of those states is California. Due to the sheer size of the market, this will most likely cause the suppliers to roll out the more efficient bulbs in other states as well. This could lead to significant energy savings.
So, why do government bans like these work? Wouldn’t the free market move in that direction anyways?
Externalities
Economists often mention things called “externalities.” These are the spillover effects of an economic transaction. A party that is not directly involved in the transaction can be effected in either a positive way (positive externality) or a negative way (negative externality).
When you look at the price of a good, that price does not reflect the externalities — given no intervention. For example, if you buy a widget from a plant that pollutes heavily, the company is not pricing the cost of pollution on society into their product. However, if the government comes in and regulates the industry and says that companies are responsible for pollution cleanup, the company will now have to price this negative externality into their product. Or they can clean up their manufacturing process, which will also increase the price of the product.
When a company includes the price of the externality into the product, it’s called internalizing the externality. However, this isn’t always feasible. Sometimes the externality is an ethical issue. Or maybe it’s just hard to put a price on the actual results of the original actions.
In the two examples above, producers of lead gasoline were not pricing the cost of lead diseases into their price. Thus, they were able to sell gasoline at a cheap price. Meanwhile, society was stuck bearing the cost of people, and especially kids, with lead related sicknesses. This may be an issue where it’s hard to actually internalize the societal cost into the product. Rather, it would be an ethical issue that requires intervention to dictate that peoples lives are more important.
In regards to the light bulbs, producers have an incentive to produce as cheap as possible in order to sell a lot of cheap bulbs at low prices from volume stores like Wal-Mart and Home Depot. Efficiency is a much smaller part of the thought process. However, could this be impacting society as a whole by using more of a finite resource (power) then it has to? To correct the process could we simply charge more per light bulb? Or would we have to place such a surcharge on the item until other options become more economical?
Tragedy of the Commons
Garret Hardin penned an article in the Science journal in 1968 which referenced a problem that is referred to as the tragedy of the commons.
The situation is this: A bunch of cow herders share a parcel of land in medieval Europe in which they are entitled to allow their cows graze. Each herder, only acting on their own behalf, will acquire new cows and let them graze on the common even if that leads to exceeding the commons capacity. Why? Because each herder receives all of the benefits, but the consequences will be jointly shared with everyone. When each herder makes an individual, yet rational, economic decision, the common will be destroyed to the detriment of all.
So logic tells us, if there is a finite good that is also a common good, people will not self-regulate themselves. As shown in the examples above, lead gas was used because of the higher octane level and the cheaper price. The total amount of unleaded gas plus leaded gas produced would be limited by the total supply of crude. To produce safer and cleaner gas, then, people would have had to chosen to forego the benefits of cheaper gas.
Insatiable Wants/Needs
Economics, whittled down to the core, is about scarcity and choice. There are a limited amount of resources available for production and we desire an unlimited amount of goods and services.
This can be seen everyday. People want better food, cars, education, healthcare, digital cameras, mp3 players, houses, etc. They want to travel to foreign countries, spend more time with their families and less time at work, and just get *more*.
You can take a look at any opinion poll and see that the majority of the citizenry expect the government to improve upon education, health, and transportation. (These questions always fail to associate these benefits with a tax dollars per person, of course!)
What am I getting at? A countries resources are limited, no matter how infinite the peoples needs and wants are. Everyday our economy uses the existing productive capabilities to attempt to uncover new wants and needs.
I mentioned above that the herders would act in a rational way for themselves. It is possible that the herders COULD get together and restrict themselves for the overall betterment of the group. In fact, game theory might suggest that. However, when applied to today’s world, people rarely behave in a perfectly informed and rational way. How often do you see people acting on imperfect or incomplete information? It is obvious that people have made poor choices about which products and services to buy, thus leading to a negative impact on themselves and society as a whole. Are these rational decisions altered by persuasive advertising? Most definitely. Emotions? Most definitely.
Government Regulations DO Work
People frequently dismiss the governments ability to regulate private markets. However, as history shows us, private markets have also demonstrated their inability to regulate private markets (aka self-regulating!).
The government DOES overstep its bounds at times, but there are also times when they are completely justified to do so because of basic economic principles.
The three basic economic principles serve to explain why industry sometimes ignores a problem even though other people are shouting about it at the top of their lungs. In some cases, the government must force “the hand” to a different spot.
What do you think?
I'm MLR. After graduating from college debt free, I decided to write a blog encouraging people to adapt responsible and sensible personal finance rules.
November 17th, 2009 at 8:13 am |
The concept of externalities is one of my favorite things to talk about. It explains so much of how the real world works.
I think of myself as a pretty hardcore capitalist–I’ve been self-employed for the majority of my working life. But it frustrates me to no end when people promote unregulated free markets as the most efficient system. They aren’t.
Mike Piper´s last blog ..Review: The Investor’s Manifesto
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MyLifeROI Reply:
November 17th, 2009 at 10:03 pm |
@Mike Piper,
Indeed, but people often times don’t like to think in terms of externalities. Personal responsibility is trumpeted often, but rarely do I hear people criticizing modern corporations for corporate responsibility. One of those responsibilities is minimizing externalities or paying the price to do so.
I know a lot of people wouldn’t think so from reading my blog, but I also consider myself a capitalist at heart. But like you I understand that regulation isn’t an enemy of capitalism… it is necessary.
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November 17th, 2009 at 9:45 am |
A great and very relevant article for today’s economy. I think the lead example is a great example how an unregulated free market won’t regulate itself for the affect it is having on outside things. Instead they look to cut corners drive down expenses and drive up profits. Lead might have boosted octane levels but was a lot worse for the environment and people in the long run. As you said it was cheaper and easier for companies. I don’t remember learning about the tragedy of commons in college but great use.
Should we look forward to a follow up post on government overstepping their bounds?
Evolution Of Wealth´s last blog ..What Is Your Greatest Asset?
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MyLifeROI Reply:
November 17th, 2009 at 10:06 pm |
@Evolution Of Wealth,
Indeed, the lead one is pretty striking because of how large of an effect it had on people. Self-regulation only goes so far.
Are we, as consumers, equally culpable because we expect low prices? That is, after all, why companies are so concentrated on cutting expenses. Their part of the blame comes in when they are doing so to increase profits.
I am glad you liked the tragedy of the commons. It’s one of my favorite economic principles because it is based in logic and rationality and people would rarely come to the same conclusion when given the scenario.
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John Sals Reply:
March 3rd, 2010 at 1:22 am |
@Evolution Of Wealth,
Do you think this recent downturn was caused by free markets? Ha. No it was not. Please please please watch this video by a man, an economist, author, stock broker Peter Schiff who predicted the last two busts.
http://www.youtube.com/watch?v=EgMclXX5msc&feature=youtube_gdata
In almost all cases, the market will self-regulate. There are times for intervention but the US economy is at a point that regulation needs to go!
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November 17th, 2009 at 12:16 pm |
Great post on scarcity of resources and economics… This stuff is surprisingly lacking on the personal finance blogs that i’ve been keeping up with. Great work on going the extra mile and bringing some sound science into it, along with personal thoughts.
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MyLifeROI Reply:
November 17th, 2009 at 10:07 pm |
@Jeff @ Sustainablelife blog,
Thanks! I am glad you liked it. If you jump into any econ rich posts, let me know. I love reading this stuff!
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November 17th, 2009 at 3:02 pm |
One of the big externalities of free markets is greed and dishonesty. If not for those two factors then perhaps the efficiency of the markets could prevail.
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MyLifeROI Reply:
November 17th, 2009 at 10:08 pm |
@Alfonso,
Greed and dishonesty cause people to act irrationally, which screws up a lot of things. You’re right, though. I don’t think those two themselves are externalities, but I think they cause a lot of negative externalities.
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Hope to Prosper Reply:
November 24th, 2009 at 7:15 pm |
@Alfonso, I think greed and dishonesty is the biggest factor. Companies figured out long ago that it’s most profitable to sell things that wear out, break or are consumed. And, consumers bought into this because it is new and conevenient. That’s why we don’t have renewable energy, low-maintenance vehicles or electronics that don’t become obsolete every three years. It’s a great business strategy for companies and consumers haven’t yet figured it out. I think the tide is slowly starting to turn.
Hope to Prosper´s last blog ..Overdraft is Over
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November 17th, 2009 at 7:48 pm |
I couldn’t disagree more when I read the title of the post. After reading through it, it actually makes a lot of sense.
I guess its hard to admit when the government actually does something beneficial for the American public, but I guess sometimes they get it right
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MyLifeROI Reply:
November 17th, 2009 at 10:09 pm |
@David/Yourfinances101,
I assumed a lot of people would scoff at the title of the post. For some reason, there are a lot of people who are conditioned to immediately push back as soon as people mention regulation.
I’m glad you read this post with an open mind and can see how regulation can actually be beneficial. Like I said, it isn’t always the case, but it certainly works sometimes.
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November 17th, 2009 at 8:04 pm |
OK, OK, I guess you convinced me that government regulations *sometimes* work BUT I think you did more to convince me of the fact that theoretically government regulations can work but in reality it seems that the government is never content to just step in and do some good but rather wants to overstretch, overspend, and overdo anything it ever does. Great job pointing out the theory behind why government regulations are, in theory at least, beneficial.
Credit Card Chaser´s last blog ..The Man With the Most Credit Cards – 1,497 To Be Exact
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MyLifeROI Reply:
November 17th, 2009 at 10:14 pm |
@Credit Card Chaser,
I’d like to delve more into the logic that “theoretically government regulations can work but in reality it seems that the government is never content to just step in and do some good…”
In the case of the lead, do you think the government did a good deed? A bad deed? Or a theoretical good deed?
In some cases it is black and white, to me. I think the government regulates a lot of things that need regulating and they do it well.
The FCC, for example, receives a lot of flak. But pretend for a second that the airwaves are the commons and the corporations are the herders. I think the regulation of the airwaves is a pretty important regulation to have, otherwise you would have a Spanish salsa station when it would be better for society to have an air traffic controller wave.
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Credit Card Chaser Reply:
November 17th, 2009 at 10:24 pm |
@MyLifeROI,
I guess the crux of my point is that many politicians seek to act in their own best interest rather than imposing regulations that would do good for the nation as a whole. In other words, the government is administered by people just like corporations are administered by people so just like people in corporations can set out to do what is in their own best interests the people running the government (i.e. politicians) more often than not seem to act in their own best interests. This why I said theoretically – because more often than not the quest for power, selfishness, greed, and the other negatives that are inherent in human nature come into play in the worst way with politicians and so the noblest of ideas are twisted into something not so noble. There are certainly exceptions of course because some politicians actually try to serve the people and not their own self interest but that seems to be a rare thing lately.
Credit Card Chaser´s last blog ..What’s Next? A Federal Government Public Option Credit Card?
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November 17th, 2009 at 8:31 pm |
Nicely written, a great resource to come back to. I think it also alludes to the fact that economics is not ethics and doesn’t include ethics in its purview at all. This alone should make us rethink economic fundamentalisms. Your description of the tragedy of the commons is great.
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MyLifeROI Reply:
November 17th, 2009 at 10:16 pm |
@MoneyEnergy,
Exactly. Emphasis: economics is not ethics
I think that’s why I really like the tragedy of the commons example. I specifically pointed out that both parties, ACTING IN THEIR BEST INTEREST, would destroy the commons eventually. So a rational decision isn’t always the best decision for the group… and this can definitely be argued in terms of ethics.
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November 18th, 2009 at 11:16 am |
Hey, great post. I actually wrote about externalities a short time ago myself. (Here, actually: http://www.theamateurfinancier.com/blog/economic-basics-externalities/) But that’s enough self-promotion from me.
Anyway, onto the main thrust of the article, I agree completely. Too often, there’s an urge to denounce government as pointless or a waste, without considering that there are some things that government can do better than private industry (if private industry would be willing to attempt them at all). Handling externalities, providing public goods (from national defense to public roads), enforcing contracts, and supplying a medium of exchange (that is, money); all of these are things that government can do better than private industry, simply by virtue of being a government.
Now, don’t get me wrong; there can and should be lots of discussion about where to draw the limits of government and what specific activities should fall within those limits. But to argue that we would be better off with no government what-so-ever is just as reckless and short-sighted as arguing that the government should be in charge of every economic activity. Neither one will result in an ideal economic climate.
Roger´s last blog ..So You Want To Invest: The Easy Method
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December 7th, 2009 at 10:43 am |
Great article! Can I copy and disribute it to my “Government Affairs in ocupational and Environmental Health” (regulatlions) course?
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March 3rd, 2010 at 1:14 am |
History shows that government regulations cause more problems. The Federal reserve is central banking form of regulation. Let’s look at why the Great Depression happened. One answer really: cheap money. Why did the .com bubble start and blow up? Cheap money. How about this recent housing bust? Cheap money (low interest rates) and government (Fannie and Freddie). You need to look Peter Schiff video that explains why the recent downturn happened? Why? Who is Peter Schiff? Peter is an austrian economist (a real economist) and a stock broker who wrote a book (he has been on all media networks) that predicted the crash when professors at Harvard said he was wrong. Man he is 2 for 2. Now he thinks the next big crash will be our currency. I hope he is not 3 for 3.
Watch his video.
http://www.youtube.com/watch?v=EgMclXX5msc&feature=youtube_gdata
He is 10x smarter than you or any of these government politicians. Regulation 99% of the time creates more problems that government blames on the free market and then they have to create more regulations to fix the regulations they put in.
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March 24th, 2010 at 9:07 am |
Who is regulating the Government?
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