Naked Economics: Undressing the Dismal Science

Chapters 3 and 4 address the role of government in economics. Contrary to popular belief, markets do not magically lead to perfect solutions on their own, and governments are necessary for improving certain situations. One main area that needs government intervention is when externalities are involved. This is when a large gap exists between private and social costs. A simple example is a law that requires dog owners to pick up their dog’s waste on public walkways. Without such rules, many people would leave the unpleasant mess behind. But the cost to society goes beyond unpleasantness; people can hurt themselves slipping on dog waste. The social cost is high (medical bills), but the dog owners pay none of it; thus, regulation is needed to close this gap.

A larger, more serious example of an externality is climate change. Businesses that burn coal gain the energy that is produced, but the collective damage to the planet is an existential cost. Again, government needs to step in to deal with this imbalance. Governments have two choices in dealing with negative externalities: ban the behavior or tax it. Wheelan is more in favor of the latter, which increases the private cost relative to the social cost, but still allows individuals to decide whether to continue engaging in the behavior.