I hate subwoofers.
There's nothing more annoying than pulling up to a red light next to someone – usually in an '89 Honda Civic with a spoiler – who is blasting music so the inhabitants of a graveyard can hear it 10 blocks away. Thanks to the 500W subwoofer, you don't hear the music. Instead, you feel it pounding inside your skull. I've long held that I could achieve the same effect by banging my head against a wall for half an hour.
But I digress.
How many times have you experienced that? How many times have you been affected by the actions of others when you have no say-so in the matter?
We all have.
Since we have all found ourselves in this situation, we can relate to the economic condition known as externalities. Defining an externality is easy: externalities occur when the external cost of some action or transaction does not accurately reflect the cost or benefit of that action to others. Essentially, the gentleman in the car does not know the cost his subwoofer is inflicting on me – a pounding migraine. This is the perfect example of an externality because the external cost of his music imposed on me is not accurately reflected to him.
Paradoxically, externalities in market transactions are both a blessing and a curse on society today.
The ever-present reality of market externalities shape the world we live in, and even a basic understanding of this phenomenon will reap many benefits.
Serious negative externalities in modern markets take different forms. The external costs from things like morbid obesity and industry pollution result in external costs to society in the form of increased healthcare costs and even premature death.
Positive externalities – which are just benefits that accrue to some third party or bystander because of an individual's actions – exist as well.
A prime example of a positive externality is education. Education is largely a private benefit, but there are positive benefits society gains as education proliferates. Harvard economist and former chairman of the President's Council of Economic Advisors N. Gregory Mankiw elaborates:
"A more educated population leads to more informed voters...lower crime rates...may encourage the development and dissemination of technologies...and higher productivity and wages for everyone."
So externalities can be positive or negative, but why should the average student at UT care?
Within the understanding of economic externalities one finds the true beauty of the free-market system. In any other economic system, private characteristics such as self-interest and ambition in the market would result in negative external costs to society as a whole.
But the free market is an entirely different animal.
It takes the natural human instinct for self-preservation and success and uses it as fuel for the engine of economic success that yields gains to the individual and society.
Bill Gates created Windows – not because of benevolence, but because he could provide a platform which would make money.
Virtually every technological innovation that built the modern world – from Cyrus McCormick's mechanical reaper to Henry Ford's automobile – was invented with one main goal: financial gains for the inventor.
When enacted in the context of the free market, actions made in self-interest render a net benefit to all – with the gains made at no expense to a third party.
Nevertheless, negative externalities are a hot-button issue for politicians. The reason they perennially appear in stump speeches and headlines in the media is simple: it provides moral justification for market intervention. Not only does this garner favorable public opinion, but it creates a moral imperative for their election. Unfortunately, the public follows blindly and the low information populace comes away believing our free-market system is fundamentally flawed.
All too often, this fallacy prevails and the economic consequences of the intervention pose a higher cost on society than the initial cost of the negative externality.
Don't get me wrong, negative externalities can be a serious problem and should be used as a metric to determine the role of government in our lives. However, in the words of Hoover Institute economist Thomas Sowell:
"[Negative externalities] do not provide a blanket justification or a magic word which automatically allows economics to be ignored and politically attractive goals to be pursued without further ado."
When addressing these problems, we must not derail the free-market system which has produced the highest standard of living society has ever seen.
Adam Prosise is a senior in economics. He can be reached at firstname.lastname@example.org.