By Robert R. Hearne, Professor

NDSU Agribusiness and Applied Economics Department

Economists believe that markets provide incentives for efficient allocation of resources.

Whenever I teach economics, I feature what I consider to be the culmination of the neoclassical economic model, The First Fundamental Theorem of Welfare Economics, which was paraphrased by Adam Smith in “Wealth of Nations” long before the neoclassical model was developed.

Simply stated, and not directly quoted, individual actors acting selfishly can create a result that the government cannot improve upon. Although this can be considered to be a conclusion of the neoclassical model, it is also a point of departure for much of economics. Economics gets more interesting once the assumptions of the model, including the assumptions of perfect competition, are dropped and we start to look at imperfect markets, asymmetric information, irrational behavior and other market failures.

My course in Natural Resource Economics features the economics of many market failures. These include public goods and externalities.

Public goods are characterized by being non-excludable and non-rival in consumption. This implies that private markets cannot be expected to adequately provide these goods because extracting payment from the consumers of these goods is difficult.

Externalities occur when third parties are impacted, positively or negatively, from an economic transaction. When we have negative externalities, such as pollution, the transaction causes harm to third parties. And unregulated private markets would overproduce these goods. When we have positive externalities, such as an individual homeowner’s effort to beautify a neighborhood, third parties receive benefits, and private markets would tend to underproduce these items.

Of course, health care is a service that is characterized by positive externalities and often non-excludability. You can’t exclude yourself from benefiting from the efforts made to reduce the spread of smallpox and polio. I consistently have used public health campaigns as an example of public goods that are not expected to be provided adequately by the private sector.

Of course, our individual efforts to maintain social distance and wear masks produce positive externalities for our communities. Maintaining the public safety protocols that are strongly suggested by medical and epidemiological experts, and are mandated in many jurisdictions, not only protects the wider community from disease but allows those of us who are vulnerable to the impacts of the disease to better enjoy our communities and patronize businesses with less fear of dangerous transmission. Indeed, some economists have deemed the act of not following public health and safety protocols as a negative externality, similar to pollution, because it can bring harm upon other people.

Unfortunately, the use of masks has become highly political and efforts to promote public health and safety have collided with a selfish sense of personal freedom. I believe that another example of a public safety norm might be illuminating.

To an economist, a norm provides an expectation of how others will act. If we have assurance as to the actions of others, we have better information about how we should act.

In North America, we follow a standard norm of driving on the right-hand side of the road. This norm has been codified, but it follows a standard good practice of traffic safety and courtesy. Certainly, this norm is much more highly accepted and followed than other traffic standards, such as speed limits.

Because we have assurance that others will drive on the right, we feel relatively safe on our roads and this enables the type of secure movement of traffic that facilitates economic activity. No controversy occurs over an individual’s right to drive on the left-hand side of the road.

Of course, the norm of driving on the right-hand side has been a common practice and accepted for many generations. Newer norms, such as the recommended practices for reducing the spread of a pandemic, may take awhile to gain a high rate of acceptance.

But we should accept that some norms will change, at least for the immediate future. The common courtesy of shaking hands might be lost for years.

So another failure of individual selfishness to produce the best economic results is the failure to follow norms that provide assurance to others. In societies where individuals are expected to follow evolving public health and safety norms, the economic activity in these areas would not be hampered by the fear to engage with society, to patronize businesses, to educate children, and to produce goods and services. In societies where we have no assurance of adherence to public safety norms, we expect limited economic growth and many other constraints to societal well-being.

NDSU Agriculture Communication - Nov. 4, 2020

Source: Robert Hearne, 701-231-6494, robert.hearne@ndsu.edu

Editor: Ellen Crawford, 701-231-5391, ellen.crawford@ndsu.edu