Lecture 04: Externalities in Practice II

Quick Overview

The lecture analyzes health externalities, primarily focusing on smoking, alcohol, and obesity, concluding that standard economic models often underestimate the optimal corrective taxes due to behavioral factors like addiction and hyperbolic discounting, which introduce significant "internalities" that must be accounted for.

Key Points: Negative externalities from smoking include increased healthcare costs (if uninsured or government-paid), reduced workplace productivity, and property damage/tax burdens from fires, though smokers also generate a positive externality ("death benefit") by paying Social Security without collecting benefits. The net negative externality for smoking is estimated to be small, around $0.50 per pack, but this ignores secondhand smoke, which is an externality because the air is not owned (no Coasian solution), and ignores internalities. Behavioral economics modifies the standard model by introducing hyperbolic discounting (beta factor), explaining self-control problems where individuals fail to act in their long-run best interest, suggesting optimal cigarette taxes could rise to $10 per pack with a beta of 0.6. Alcohol consumption carries massive negative externalities, primarily from drunk driving ($250 billion annually) and association with criminal activity/spousal abuse; the optimal tax should be roughly four times current levels. Obesity is a massive health crisis, shortening lifespan by an average of four years for 40% of obese Americans, driven by cheap, unhealthy foods and decreased physical activity, and is harder to address with taxes than smoking due to eating being non-linear. The opioid crisis exemplifies policy backfiring: efforts to create abuse-deterrent OxyContin shifted addicted users to more dangerous substances like heroin and fentanyl, leading to over 100,000 annual overdose deaths. The concept of "internalities," damage done to oneself not captured by standard models due to issues like addiction or self-control problems, drastically increases the optimal corrective tax for behaviors like smoking.