Lecture 19: Externalities

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Lecture 19 Externalities Health
Richard Smith Reader in Health Economics School
of Medicine, Health Policy Practice
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Overview of lecture

• What are externalities?
• Positive externalities and health
• Negative externalities and health
• Global externalities and health
• Externalities and public goods

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What are externalities?

• Costs and/or benefits of actions by one party
  which affect other parties
• Externalities exist wherever a transaction
  affects an uncompensated party
• Policy issue design of appropriate institutions
  legislation to align individual incentives
  social welfare
• Externalities (with public goods) are main reason
  for public health care systems worldwide

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Positive externality

• Positive externality where social benefit of
  consumption of good exceeds private benefit
• Private benefit benefit to consumers who buy
  and consume good
• Social benefit benefit to all in society,
  including those who do not consume it
• ? Equals private benefit of consumption plus
  benefit to others
• Causes market failure (too little consumption)

5
Positive externalities health

• Caring for health of others (Good Samaritan)
• interdependent utility functions
• UAU(hA, yA, hB) UBU(hB, yB, hA), where
  hhealth, yincome (other goods)
• Private health increases national wealth
• Knowledge technology
• Communicable disease surveillance infectious
  disease control (Lecture 21)
• Vaccination (herd immunity effect)

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Positive Externality
P
S MPC MSC
D MPB
Q
7
Positive Externality
P
S MPC MSC
A
Equilibrium Price PA
D MPB
Q
QA
8
Positive Externality
P
S MPC MSC
A
Equilibrium Price PA
D MPB
Q
QA
Equilibrium Output
9
Positive Externality
P
S MPC MSC
Consumer Surplus
A
Equilibrium Price PA
Producer Surplus
D MPB
Q
QA
Equilibrium Output
10
Positive Externality
P
S MPC MSC
Consumer Surplus
A
Equilibrium Price PA
Producer Surplus
MSB
D MPB
Q
QA
Equilibrium Output
11
Positive Externality
P
S MPC MSC
B
Consumer Surplus
A
Equilibrium Price PA
Producer Surplus
MSB
D MPB
Q
QA
QB
Equilibrium Output
Herd immunity (eg 80 coverage)
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Positive Externality
P
S MPC MSC
B
Consumer Surplus
A
Equilibrium Price PA
Producer Surplus
MSB
D MPB
Q
QA
QB
Equilibrium Output
Economically Efficient Output
13
Positive Externality
P
S MPC MSC
B
Consumer Surplus
A
Equilibrium Price PA
Producer Surplus
MSB
D MPB
Q
QA
QB
Equilibrium Output
Economically Efficient Output
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Positive Externality
P
Total Gain to Other People
S MPC MSC
B
Consumer Surplus
A
Equilibrium Price PA
Producer Surplus
MSB
D MPB
Q
QA
QB
Equilibrium Output
Economically Efficient Output
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Positive Externality
P
Total Gain to Other People
S MPC MSC
B
Consumer Surplus
A
Equilibrium Price PA
Producer Surplus
MSB
D MPB
Q
QA
QB
Equilibrium Output
Economically Efficient Output
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Positive Externality
P
Deadweight Social Loss
Total Gain to Other People
S MPC MSC
B
Consumer Surplus
A
Equilibrium Price PA
Producer Surplus
MSB
D MPB
Q
QA
QB
Equilibrium Output
Economically Efficient Output
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Policy options

• (Pigouvian) subsidies to internalize external
  benefit
• changing private benefits so they equal social
  benefits, such as providing free vaccines
• Direct provision of good, such as vaccine
• Property rights to correct market (e.g A owns
  right not to be vaccinated, or B owns right to
  vaccinate) UK vs USA schools

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Negative externality

• Negative externality where social cost of
  consumption of good exceeds private cost
• Private cost cost to consumers who buy and
  consume good
• Social cost cost to all in society, including
  those who do not consume it
• ? Equals private cost of consumption plus cost
  to others
• Causes market failure (too much consumption)

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Negative externalities health

• Infectious disease
• Large part of reason behind public health
  movement in 19th Century (UKPHLS/HPA
  USAPHS/CDC)
• Lecture 21 antibiotic resistance
• Environmental degradation (vehicle emissions)
• Child day care
• individual vs social costs and benefits
• Tobacco passive smoking

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Equilibrium with a Negative Externality
Price/ Cost
Quantity
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Equilibrium with a Negative Externality
Price/ Cost
S (MPC)
D (MPB/MSB)
Quantity
22
Equilibrium with a Negative Externality
Price/ Cost
S (MPC)
A
Equilibrium Price PA
D (MPB/MSB)
QA
Quantity
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Equilibrium with a Negative Externality
Price/ Cost
MSC
S (MPC)
A
Equilibrium Price PA
D (MPB/MSB)
QA
Quantity
24
Equilibrium with a Negative Externality
Price/ Cost
MSC
B
S (MPC)
A
Equilibrium Price PA
D (MPB/MSB)
QB
QA
Quantity
25
Equilibrium with a Negative Externality
Price/ Cost
MSC
B
S (MPC)
A
Equilibrium Price PA
D (MPB/MSB)
QB
QA
Quantity
Equilibrium Output
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Equilibrium with a Negative Externality
Price/ Cost
MSC
B
S (MPC)
A
Equilibrium Price PA
D (MPB/MSB)
QB
QA
Quantity
Economically Efficient Output
Equilibrium Output
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Deadweight Social Losses From Smoking
P
MSC
MPC S
D
Q
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Deadweight Social Losses From Smoking
P
MSC
MPC S
A
PA 3
D
Q
QA
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Deadweight Social Losses From Smoking
P
MSC
10
MPC S
A
PA 3
D
Q
QA
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Deadweight Social Losses From Smoking
P
MSC
10
MPC S
A
PA 3
D
Q
QA
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Deadweight Social Losses From Smoking
P
MSC
10
Deadweight Social Loss
MPC S
A
PA 3
D
Q
QA
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Deadweight Social Losses From Smoking
P
MSC
10
Deadweight Social Loss
B
PB 5
MPC S
A
PA 3
D
Q
QB
QA
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Deadweight Social Losses From Smoking

• NOTE the economically efficient level of
  production is not zero!
• ? It would mean doing completely without
  goods yielding some benefit
• Economically efficient level occurs when marginal
  benefit of reducing externality equals the
  marginal cost of reducing it
• Policy issue is how to achieve this level

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Policy options

• (Pigouvian) taxation to internalize external
  cost (e.g. cigarettes, petrol)
• changing private costs so they equal social costs
• Regulation of overall quantity produced
  (rationing e.g. cigarettes, petrol)
• Property rights to correct market (e.g. A
  owns right to clean air, or B owns right to
  pollute air determines flow of compensation,
  subsidy, tax etc)

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Taxation
P
Old MPC
A
D
Q
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Taxation
New MPC MSC
P
Old MPC
A
D
Q
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Taxation
New MPC MSC
P
Old MPC
B
PB 5
A
D
QB
Q
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Taxation
New MPC MSC
P
Old MPC
B
PB 5
A
PS 2
D
QB
Q
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Taxation
New MPC MSC
P
Old MPC
B
PB
A
Tax 3
PS
D
QB
Q
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Problems with taxation

• Taxation may not internalize all externalities
  (demand subject to other influences)
• Taxation can internalize externalities only if
  transactions costs (implementing the taxation
  system) are sufficiently low
• Coase theorem

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Coase Theorem

• Equilibrium is economically efficient regardless
  of who holds property rights producer or
  consumer when transactions costs are low
• BUT Equilibrium not economically efficient when
  transactions costs are high depends on property
  rights, laws etc

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Regulation

• Direct government intervention to determine
  quantity of production/consumption (rather than
  indirectly through price)
• Though incentives/quotas (e.g. vaccine targets,
  incentive payments to GPs, congestion charge)
• Through legislation (e.g. smoking in public
  places)
• Through production/distribution (e.g.
  communicable disease surveillance)

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Problems with Regulation

• Costs may differ between firms and/or consumers
  which may not be accounted for
• Uncertainty over MSB/MPB and MSC/MPC curves
  (required to set optimal equilibria)
• Political costs
• Transaction costs

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Global externalities health

• Communicable diseases
• HIV/AIDS global (geographic demographic)
• Tuberculosis - global (geographic demographic)
• Malaria - regional (geographic)
• Acute Respiratory Infection, Diarrhoea local
  (geographic demographic)
• Economic effects of ill-health
• HIV/AIDS in Southern Africa regional to global

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Global externality (re)emerging infectious
diseases 1996-2003
Legionnaires Disease
Multidrug resistant Salmonella
Cryptosporidiosis
E.coli O157
E.coli non-O157
Typhoid
BSE
SARS
Malaria
nvCJD
Diphtheria
West Nile Virus
Reston virus
Echinococcosis
Lassa fever
Nipah Virus
Yellow fever
Cholera 0139
Reston Virus
RVF/VHF
Venezuelan Equine Encephalitis
Buruli ulcer
Dengue haemhorrhagic fever
Onyong-nyong fever
Ebola haemorrhagic fever
Human Monkeypox
Dengue haemhorrhagic fever
Cholera
Cholera
Equine morbillivirus
Hendra virus
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Cost of global health externalities
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Externalities public goods

• Goods with significant positive externalities are
  often public goods
• Goods with significant negative externalities
  are, conversely, public bads
• Public goods (bads) are under (over) consumed for
  additional reasons
• Lecture 20!

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Further references

• McPake B, Kumaranayake L, Normand C (2002),
  Health Economics an International Perspective.
  London Routledge. Chapter 8.
• Getzen T (2004). Health Economics fundamentals
  and flow of funds. New York Wiley. Chapter 15.
• Smith RD, Coast J. Controlling antimicrobial
  resistance a proposed transferable permit
  market. Health Policy, 1998 43 219-232.
• Coast J, Smith RD, Millar MR. An economic
  perspective on policy to reduce antimicrobial
  resistance. Social Science Medicine, 1998 46
  29-38.
• For future ref
• Smith, RD, Drager N. Cross-border risks and
  public health security. Oxford University Press.
• Smith RD, Drager N, Hardimann M. The rapid
  assessment of the economic impact of public
  health emergencies of international concern.
  World Health Organization.
• Yeung RYT, Smith RD. Can we use contingent
  valuation to assess the private demand for
  childhood immunization in developing countries?
  Applied Health Economics and Health Policy.