Mankiw's Principles of Microeconomics Chapter 10

1. What is your favorite example of a negative externality?  Could the problem be solved via negotiation (Coase Theorem)?  How or why not?

According to Harvard professor Gregory Mankiw, an externality can occur when a person or a company engages in an activity that influences the well-being of a bystander but neither pays nor receives any compensation for that effect.

An example of a negative externality would be the BP gulf oil spill that occurred most recently. The downstream affects from the pollution severely impacted the fishing industry of the gulf. Normally in the case of negative externalities the government could impose regulation or corrective taxes to limit the amount of pollution that occurs; however, in the case of an oil spill, the government could not have acted quickly enough to enact the regulation or corrective taxes needed that will have paid for the required environment offsets or incented the correct corporate behavior.

Shortly after the spill, BP scrambled to control its image as an environmentally responsible corporation; however, the allocation of their own financial resources would show otherwise. BP drafted plans to spend approximately $50 million in TV ads that would focus on relaying to the public the plans they had in place for disaster mitigation. At the same time, another $10.5 billion in shareholder dividends were going out the door. With as much financial variation between PR and stockholders, it was understandable why many felt the social and financial impacts to the local economy weren’t getting the attention that was deserved.

When the current administration pointed out to BP the social and moral obligations they had to the community, BP responded with a resolution that could be viewed as a private resolution to a negative externality (Coase Theorem). BP propositioned the local fisherman to pay for their lost income due to their inability to fish, or the extra fuel spent because of the need for them to go further out to sea to achieve the same result. In some cases, BP also offered to pay for the fisherman’s assistance in the clean-up effort, thereby reallocating resources that were once meant for fishing. In the end, the outcome for both parties were mutually beneficial and that in and of itself is Coase Theorem at work.