Externality- a definite Highlight
In reading the first 5 chapters of Harford’s book, “Undercover Economist” I learned the meaning to a word that was formerly foreign to me. This word should be remembered by everyone as it is applicable in almost all aspects of life, not only in economics. This word is externality and it is unique to me because I feel that it is something that most people know about, like myself previous to my reading, but can not really explain the worth of its existence. The definition of externality in the context of economics is explained by Harford as; “a side effect, because it lies outside the original decisions.”
The relevance of remembering externality is to assist in looking at decisions from other perspectives than just result. For instance externalities can be applied when visiting a doctor for back pain. The doctor might prescribe a pain relieving medication. Obviously the medication is going to alleviate the pain, but what are the externalities associated with taking this medication. Most people ask about these externalities because they ask about the side effects, like whether the medication will cause sleepiness or an upset stomach. More importantly is the subtle real life externality. This is exemplified by a young person who starts working at a job, with upward mobility, in high school. This person continues working full time at this job into college until junior year when this person is promoted to a stepping stone position, somewhere between hourly worker and salaried executive. This person likes this position because it has more perks, it pays better and it is just one step away from a full blown career as an executive making a hefty salary. The downfall is that this person will only be able to attend college part time, and after a while decides that college is not needed in their career so college is given up altogether. Just as this person predicted after about a year, the person is promoted into the executive position and is very happy for a few more years. After a few years there is opportunity for advancement to a vice president position, the only hang up is that the competition has a college degree in a related field but has less job experience. The decision is made and the competition is promoted, justified by the college degree. Now this person realizes the side effect or externality of not having the college degree. Had our person looked at all perspectives before deciding to drop out of college, the decision might have been to keep plugging along with college until completed as there is the possibility of more opportunity in the future.
Once I was able to understand externalities in every day situations it was easier to apply the instrumental role they play in much larger arenas. Harford provides a great example that really helped me to consider the depth of a controversial and very timely matter. Harford refers to oil refining, gasoline retailing and the price a driver pays for the gas, where the result is the negative externalities of pollution, local poisoning and global warming. Economists consider whether these externalities could or should be included in the price the driver pays for gas, or whether the oil company should pay the extra charge for these externalities. More importantly since consideration is given for charging for the externalities, how do we measure them in cost? This is the real economic thought process, which embarrassingly enough I had never thought about before.
Many examples can be used to convey externalities of various decisions. The most important aspect of externalities is that they exist and are fundamental in all decision making processes. Many of us are quick to make decisions or form opinions but by remembering how to figure out the externalities we might be able to decide without future regret. Thank you Harford.