By David Henderson
In my Executive MBA economics class a little over a week ago, I presented the following definition of a negative externality:
A cost borne by someone who is not party to the decision that caused the cost.
Then I asked the students for examples of negative externalities. One tried and true example in the textbook, The Economic Way of Thinking, by Heyne, Boettke, and Prychitko, is air pollution. I was ready to go with that if the students didn’t come up with anything. They typically do, though, and so I didn’t have to wait long.
One student raised her hand and I called on her. She gave the example of a school board of a government school district that had voted for large pensions for teachers, pensions that would be paid for by taxpayers rather than by the board members themselves.
I could have hugged her.
So often we economics professors stick to the kinds of externality examples we were taught when we learned economics. And that was my mindset that morning. But there’s a sea of examples of externalities, typically negative, created by government officials. She put her finger on one.
I wrote about Harold Demsetz’s example earlier here.
Update: Glen Whitman has written about this here.