Economic Analysis of Social Media

The introduction and growth of new technologies for communications has affected the world in an exponential manner, pertaining to business and the economy, and considering new pathways of marketing products. As we know, aggregate supply has been shifting positively since the 90s due to the increase in complicated technologies, with the internet arguably having the greatest growth magnitude in human history. I am here to discuss the costs of a particular subset of new internet technology, social media.

The Financial Times displays a new and costly view on the introduction of social media to the developed world (here). We have any piece of information that we want to know in our pocket; it can be accessed with a few taps of our thumbs. As we can provide through anecdotal evidence, such simplicity regarding access to information is immensely distracting. Right now I could completely neglect this assignment and decide to watch random Youtube videos, a guilty pleasure that is most harmful to an imperative aspect of modern life, which is productivity. As displayed in the article, it is shown that when global smartphone shipments sharply increased, productivity growth in advanced economies measured in percentage points sharply declined. Although we must keep in mind that correlation does not equal causation, this is an interesting point. Advertising strategies today are near subliminal levels, which bridges to the next point of the article; this attention capturing strategy potentially correlates negatively with a persons true underlying preferences. The "click bait" strategy of the internet age simply does what it is designed for and what the name implies. Since a consumer's utility function is dependent on the goods that a consumer consumes and is maximized with that consumer's budget, this creates an inaccurate demand curve. It seems clear that there are some problems with the way that the modern citizen of a developed country operates due to these theories.

The decrease in productivity growth caused by social media is a negative consumption externality. When an individual engages with social media during work or during a situation in which that person is supposed to be doing something productive, that person's lack of production causes the company or the people around them to bear the cost of their lack of production. That person's coworker's or peers has to make up for their lack of production to cover the dead weight loss or they just bear the cost. Considering this void in the market for productivity, it is unclear who should bear the cost of this externality to reach allocative efficiency. Should that person pay for the value of the production lost due to their social media usage? Should the social media company pay this cost for distracting the worker? If it is assumed that this extenality is happening on a large scale and the the worker is not liable for damages, there is a holdout problem. I imagine, for example, a company blocking websites on their internet network, then the workers becoming fed up with the controlling nature of the company, saying they don't get paid enough to be worked so hard with so few breaks, and finally, those workers taking action and causing more damage to the company. Many companies may say that these workers are lazy and unproductive, but they may neglect the very root of the problem with the unproductive modern worker. This article argues that the "click bait" advertising done on the internet causes people to be less mindful in their decisions, caring less, and in turn making people less empathetic. If we assume that empathy is a desired social characteristic, then we can say that social media is creating a negative production externality in the market for empathy by decreasing the mindfulness of people. This, which is such an abstraction, I find to be most interesting. There is great cost to be paid when on a large scale people are not empathetic; discriminatory laws are passed, businesses act without regard for their people, financial crises happen, greed runs rampant, crimes are committed..., and many others. Considering that this cost is at this point immeasurable, who should bear it? The person who lacks empathy? The causer of this person's lack of empathy? What problems does this new social norm entail?

Wine&Beer Fest

Back in Guayaquil, EC the building where I live is located right in front of the local theater. The theater hosts different types of events that range from music and food festivals to children entertainment on weekends. These events take place in the open parking lot, which implies that noise cannot be contained and cars have to park on the streets surrounding the theater, blocking the way for regular transit. Residents in my building are affected by the noise that goes on until late hours in the evening, and by the overflow of cars in the streets that often block the entrance to the building. These two effects are negative production externalities. They impose a cost to the residents that is not accounted for by the producers, leading to a MSC that is above the PMC and therefore results in an overproduction of the good (events in the theater parking lot).

Last week all residents in my building received a letter from the representatives of the “Wine & Beer Fest” that is scheduled to take place in the theater parking lot in October. Their permission to have the festival was denied by the mayor due to repetitive noise and traffic complaints by the building’s residents. This letter is a clear example of a Coasian solution for a negative externality. In the letter, the representatives of the festivals request the residents to cooperate with them in order to reach a “favorable” solution. They mention various arrangements they would be willing to make for the residents to withdraw their complaints. These include: rescheduling the event to an earlier time in the evening, request the presence of more transit officers to ensure the clearing of roads, providing VIP tickets to all residents of the building and any other suggestion or request.

This situation shows not only a negative production externality problem but also the role of government, and a possible solution. The negative production externality created by the festival would be the noise and traffic that residents in the area have to endure when these event takes place. The role of government is clear; they assigned property rights to the residents when denying the permit to the festival. But, as proposed by Coase, the government does not impede the negotiation between the two parties involved. The producers are trying to negotiate a solution with the residents by modifying their production. By doing so, they are internalizing the externality by accounting for these costs. For example, all the VIP passes given out for free are added to the company’s costs. This internalization of the externality raises the PMC to the SMC solving the externality problem. Residents agreed to these terms and tickets for the festival are now on sale! 

Weaknesses of "Not a Public Good" Arguments Against Higher Education Funding

In arguments about public education, many people debate whether or not education is a public good in which the government should invest. Strong proponents of public education (like UVA’s own Thomas Jefferson) often define education as a public good, while others (like economists) remind us that goods with positive externalities are not necessarily public goods. It is true that education is not a pure public good; education is neither non-rivalrous nor non-excludable. Education policy researcher Preston Cooper emphasizes this point in his Forbes piece arguing for students bearing “some or most of the cost” of higher education because it is not a pure public good. Although there are definite costs and benefits to relative levels of government funding of higher education, the argument against government provision of higher education because it is not a pure public good is not completely sound.

In Externalities: Problems and Solutions, Gruber explains that “most of the goods we think of as public goods are really impure public goods, which satisfy these two conditions to some extent, but not fully” (170). For example, cable TV and private parks are excludable, but not rival. Although higher education is excludable, higher education is a lesser degree of rival than are other goods that the government provides. While college classrooms have maximum capacities and different types of courses have different optimal numbers of students, college class sizes are typically larger than those of primary and secondary schools. For example, more than 450 UVA students attend introductory micro and macroeconomics lectures at the same time without negatively affecting each others' learning. There is a point at which higher education becomes rival, but higher education falls closer to a public good on the continuum we discussed today than public education currently provided by the government. While the government provides many services with positive externalities that are not public goods and higher education being a purer public good than primary and secondary education does not necessarily mean that it should also be free, analyzing the extent to which higher education is non-rivalrous addresses arguments like Cooper’s that since higher education is “unambiguously not a public good,” it should not be publicly provided.

When Nobody Takes Out the Trash

I currently live in a house with 15 other people. A major issue within the house right now is that nobody except for a select few (such as myself) ever take out the trash. In this post, I will use Ronald Coase’s framework to try to find a solution. 

Firstly, we must determine what kind of externality we are dealing with. This situation is slightly more complicated than the basic “Confectioner vs. Doctor” example. In my house, there are 15 people, each of whom acts as both a “Producer of Trash” and a “Consumer of Cleanliness”. In this case, we have a negative production externality, where the allocatively efficient output would be less trash produced at a higher price. When individuals produce more trash than the allocatively efficient quantity (where Q = Trash Thrown Away – Trash Taken Out), then it damages the utility of the consumers of cleanliness. It may seem that this should not be an issue, because in this example the consumers are the same individuals as the producers, but different preferences between individuals create a market inefficiency. For ease of explanation, let’s say there are two groups of people. Group 1 has no preference between a clean house and a dirty house, so their marginal cost of producing trash is zero. Group 2 does prefer a clean house to a dirty house, has a high marginal cost of producing trash, and therefore takes out the trash frequently to decrease their overall production. In the market with an externality, Group 1’s actions as producers harm Group 2’s utility as consumers, because the individuals in Group 2 incur a cost by living in the dirty house.

Coase’s theorem would suggest that the best way for me to deal with this problem as a member of Group 2 is to pay the members of Group 1 a negotiated amount so that they take out the trash. This would produce the allocatively efficient outcome because this payment would shift Group 1’s production cost curve up, and they would produce less trash. Group 1 would never pay more than the value of damages that the externality causes them. Therefore, Coase’s strategy should work and solve our house’s trash problem. However, while this solution should theoretically work, I do not think it will happen, even if that means I am acting economically irrational- I just cannot stomach the idea of actually paying my friends to do what is expected of them and take out the trash.  In this example, the cost of violating my moral principles serves as a transaction cost, which violates the assumptions of Coase's theorem and explains why this solution may not actually work in practice.

Make the Subway Grate Again

Last winter, I was walking around the blustery streets of New York in the middle of December. It was relatively warm in the morning, but by sunset the temperature dropped precipitously and I was significantly underdressed. Walking down the street, shivering, I noticed that some of the subway ventilation grates on the sidewalk released gusts of warm air. Once I realized this, I began leapfrogging from grate to grate, spending a few moments at each to warm up before darting to the next one. I was not a party to the transaction, yet I certainly benefited from the fact that the subway cars below me were running and producing heat. Clearly, the heat coming up from the grates constitutes a positive production externality.

This summer, while walking to lunch under the sweltering sun I again passed over one of these vents and my opinion of them shifted dramatically. Whereas in the winter these vents provide a much needed respite from the cold, in the summer they make the already stifling sidewalk that much more unbearable. Instead of a positive production externality, the heat coming out of the grate was a negative production externality.

This complicates the situation significantly. The implications of internalizing the externality would depend on the time of year (or even the day-to-day weather conditions). Aside from the fact that it would be practically impossible to charge or credit whoever walks near one of the grates, the party being compensated would change periodically regardless of who’s assigned liability by the law.

It turns out that the MTA has decided to do away with the grates altogether in their new projects, removing their associated positive and negative production externalities (Note that there were other negative production externalities that accompanied these grates, such as the tendency to collect dropped jewelry and break women’s high heels, which I have not accounted for in this analysis). On the newer lines (such as the second avenue subway), hot air is instead vented out of mechanical ventilation towers.

Should Students Give More Wrong Answers?

After presenting the concept of concurrent supply and demand shifts last week in my ECON 201 discussion section, I asked for a volunteer to draw up on the board what might happen to the market for uber rides on New Years. (Answer: demand increases and supply decreases causing price to skyrocket.) I was met with silence and wide eyes. My students were extremely hesitant to give a wrong answer. I began to wonder why that might be. Clearly, giving a wrong answer in class has a high psychological cost, embarrassment, which, for most students, greatly outweighs the individual benefits. However, given our discussion of externalities last Monday, it seemed like there might be more to the story.

Providing a wrong answer in class has a positive production externality, meaning, its production provides a benefit to an independent party which is not felt by the producer, leading to an allocatively inefficient output. When a student supplies a wrong answer in class, she helps other students by giving the instructor an opportunity to explain why her answer was wrong, often clarifying the logical path to the correct answer. Cunningham’s Law calls attention to this phenomenon in less explicitly economic terms by pointing out that the best way to get a right answer to is give a wrong one. Because individuals do not properly account for the additional social benefit of giving an incorrect response, wrong answers are underproduced.

Even more interesting are the possible solutions to this particular market failure. Under Coasian theory, the class could strike up a bargain with the mistaken answerer, providing her with an incentive, typically monetary, to increase production. (While the mistaken student could also pay the class for the harm done to them by not answering incorrectly, it appears that the property rights have been naturally assigned to to the speaker here). This solution, however, falls prey to both of the major flaws in Coasian theory, the holdout problem and the free rider problem. Presumably, the class has more than two students, providing the last student who pays with an incentive to pay less or not at all. Similarly, the paying students have an incentive to free ride on the compensation of their peers, showing reluctance to contribute to the purchase of the good (the wrong answer) which produces social benefits. Both these problems might lead to a collapse of the solution in the private market. In this case the government (the instructor), would have to step in to subsidize the provision of incorrect answers in order to achieve the allocatively efficient output.

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Peruvian Wonder Retains Beauty Despite Destructors

I dream of one day visiting every single wonder of the world. Last December, I was able to cross Machu Picchu off my list. It was remarkable.

But in the process of arranging the trip, I was surprised to see the immense amount of regulation placed on the historical site and the city it resides in. Machu Picchu is in a city called Aguas Calientes in Peru. As tourism has begun to increase at an exponential rate, the country has taken precautions to mitigate its effects. While these regulations can be annoying at times, it’s important to understand why they exist, why they continue to become more stringent, and how they contribute to economic efficiency. This understanding comes first from recognizing the effect that the business of tourism at Machu Picchu has on the site itself. Tourism can present huge negative externalities on the site of Machu Picchu and the village its entrance resides in. These externalities are driven by tourist consumption. Therefore, I argue that the massive crowds at Machu Picchu present a negative consumption externality. The thousands of tourists who enter the ruins of the ancient Incan civilization can be somewhat unsurprisingly, extremely destructive: they climb structures, erode the land, take stones, and damage the area. (Not to mention that it's virtually impossible to get a photo without these tourist hoardes in it.) Which, in turn can hinder the experience for future visitors. But that’s not where their impact stops. The thousands of tourists that flood the village of Aguas Calientes everyday make life for those who reside there permanently difficult. While tourism accounts for a huge portion of revenue for the village, it also causes massive overcrowding.

But the concept of this negative consumption externality at Machu Picchu isn’t a new one. Peru has been trying to mitigate it for decades and continues to do so through both regulation and price hikes. For instance, in addition to regulating the number of people allowed to enter Machu Picchu, Peru also controls when they may enter/leave, how long they may stay, and how quickly they must complete their hikes of Huayna/Machu Picchu mountain. These regulations literally limit the number potential destructors of the citadel by putting a cap on consumption. What makes these regulations even more effective are the high prices that come along with them. To get to Aguas Calientes, you often must take a plane, bus, and a train—all with individual ticket prices. After you get there, a single bus ticket to get up and down from Machu Picchu can cost anywhere from $50-$75. Once you get to the top, entering the ruins costs another ~$50. If you want to do any of guided hikes, that costs ~$100 and needs to be completed in under 4 hours. These price hikes partnered with stringent regulation limit the number of people who can afford to travel to Machu Picchu and thus limit consumption of the area, thereby mitigating some of the negative externalities it imposes and preserving the beauty of the Machu Picchu ruins for a little longer. Hopefully long enough for the next one of us wandering wahoos to visit.

Machu Picchu (2017), Wandering Wahoo Collection; Sabrina Grandhi

Cattle and Methane

Our discussion on externalities and Robert Coase’s analysis of the interaction between a cattle-producer and a farmer reminded me of a similar issue regarding global warming that I studied in high school. For meat-lovers, including myself, a nice 12-oz New York Strip steak is a delicacy. However, the production of livestock, like cattle, to feed the large community of meat-lovers results in a strong example of a negative production externality. Cows produce methane, a powerful greenhouse gas that contributes to the rise of global temperatures. Clearly, then, the social marginal cost (SMC) of raising cattle for human consumption equals the private marginal cost (PMC) that the producer of the cattle is responsible for when raising livestock plus the additional marginal damage (MD) that the release of methane places on the environment and our wellbeing. If no action is taken, there will be an overproduction of cattle and even greater amount of the greenhouse gas being released (Q_{AE <} Q*). To fix this problem, what should be done?

If we lived in a world where everyone loved a good New York Strip, then the social marginal benefit of producing cows for consumption would certainly outweigh the social marginal cost of the methane being released into the atmosphere. Unfortunately, for all meat-lovers, this is not the case. A bargaining solution would not be feasible in this situation because it would lead to both a free-rider and a holdout problem- there are just way too many people that are either liable or not liable to find any clear consensus. Hence, there needs to be government intervention beyond assigning property rights, in the form of taxes, regulations, and subsides. The article Meat Is Horrible articulates government intervention in the form of a “meat tax”. Another solution could be regulations aimed at capping the number of cows a farm can grow in order to control the levels of methane being released. Finally, subsidies could be used to incentivize farmers to use a certain type of feed that will reduce the amount of methane released by the cattle.

Meat is not horrible, but a solution needs to be found to alleviate the effects of the negative production externality caused by the growing of cattle for consumption.  

Application of Coasian Theory in India

This summer, I was able to listen to a presentation by Shruti Rajagopalan, an economist whose primary interests include public choice and development economics. In her presentation, she discussed Gurgaon, a city in India with a population of approximately 2 million. Gurgaon, unlike typical cities in India or around the world, has developed over the past thirty years through the private provision of goods that are typically funded by the government, such as infrastructure, transportation, and security. Rajagopalan’s paper with George Mason economist Alex Tabarrok about the topic can be found here.

This city, where private firms fund public goods based on their individual demand curves, gives us an interesting scenario with which to study externalities. Without government intervention to solve market failures through taxes and government regulation, they are left to Coasian solutions to solve market inefficiencies. These inefficiencies will persist if the Coasian theorem of ‘internalizing the externality’ fails. If we assume that property rights are well defined within the city (not an entirely accurate assumption but reasonable enough to tell the story), then Coase’s theory suggests that bargaining will bring about the socially optimum quantity of desired goods. This may work in certain markets, but Rajagopalan and Tabarrok’s paper suggests that large-scale infrastructure such as sewage and electricity are lacking. This is likely due to the free-rider problem, because there are a large number of individuals in the city, each of whom shares the responsibility of funding the public goods. Therefore, large-scale goods such as sewage will see underinvestment, and waste treatment plants will be operating below the allocatively efficient quantity.

Gurgaon has grown faster and seen relatively more corporate success than most other areas of India, but its private model still has issues such as that which I discussed above. I think that this topic of private provision vs. government solutions is quite interesting, and you may see me bring up this example again if it relates to any future posts about public choice.

The Negative Externalities of Corporate Culture

In our class these past two weeks, as well as in the 2010 discussion sections I am teaching, we have discussed the classic examples of externalities - pollution, parks, smoking, etc. However, another interesting (and relevant) market failure is that of companies with sub-optimal levels of cultural capital. In “The Economics of Why Companies Don’t Fix Their Toxic Cultures,” Kevin Stiroh defines cultural capital as a form of investment subject to market failures that explain why companies often fail to address poor corporate cultures. Investing in cultural capital reduces employee misconduct risk, just as investing in physical and human capital reduces liquidity risk and operational risk. The higher the cultural capital, the lower the misconduct risk and the greater alignment between a company's business outcomes and stated values. On the other hand, stated values and employee behavior differ in firms with low levels of cultural capital, yet many companies (like Uber until 2017) do not invest in cultural capital to mitigate this misconduct risk.

Firms do not invest in cultural capital for a variety of economic reasons relating to market failures. Externalities is one of them - employee misconduct creates externalities like lost consumer confidence in the firm and in the entire industry. This requires the assumption that consumers lose confidence both in firms with negative corporate cultures and in the overall sectors of these misbehaving firms. For example, a few powerful financial institutions made consumers lose trust in the entire financial sector during and after the Great Recession, and a few high-profile tech companies have led many people to question the values of the tech industry as a whole. Therefore, individual firms do not always incur all of the costs of their own misconduct. This leads to a negative production externality - firms with low cultural capital impose a negative externality on third parties, like other companies in the industry that have high cultural capital. Since these firms do not bear all of the costs of their negative corporate cultures, they do not take appropriate action to reduce their misconduct risk.

Market failures have implications for many business decisions beyond our typical examples of farmers and cattle-raisers. Negative corporate cultures, from financial irresponsibility to sexism, and companies’ unwillingness to improve them can be explained in part by uncorrected negative externalities.

Engaging in political activity and the free rider problem

This past week, I spent some time volunteering for a local political campaign in Charlottesville. It strikes me that the efforts of anyone volunteering for a political campaign may in fact have positive externalities, a perspective I hadn’t yet considered. Assuming one is volunteering for a candidate who supports policies that are socially optimal – or at least more socially beneficial than those of their opponents (very big assumptions, to be sure) – a volunteer’s work on behalf of a campaign can create benefits for society. As a volunteer puts in more work, they may sway more voters, and increase the likelihood that their candidate gets elected. The benefit from each additional hour of of unpaid work from a volunteer is shared by all of a candidate’s constituents who benefit from the policies they might implement once elected. In other words, that extra hour of work has a greater social benefit than the private benefit which the volunteer alone receives by volunteering.

An implication of this is that volunteering on political campaigns will be underproduced, because many people would have an incentive to “free ride,” benefitting from the volunteer work of others who help elect the preferred candidate. Of course, this implication comes from assumptions in an ideal world: the assumption that one candidate has consistently socially optimal policies; the assumption that those policies benefit a large proportion of their constituents; the assumption that more volunteer hours consumed leads to a higher likelihood of the candidate winning; and the assumption of perfect information availability about the impacts of a candidate’s policies. In the real world, many of these assumptions don’t hold, and individuals’ policy preferences are highly subjective. This is the difficulty with social benefits and costs: they are very difficult to measure and to account for differences.