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Why Costs Should Count

December 1, 2001


Douglas Clement Senior Writer
Why Costs Should Count

In standard economic theory, negative externalities (or spillovers) are the rationale for regulation of polluters. Producers who don't cover the full costs of production—including the costs imposed on society by pollution—should be forced to internalize those costs. But what if regulations force producers to pay too much, to pay more than the actual costs they impose on society by polluting?

Those excess costs constitute the opportunity costs of inefficient regulation: What else might be done with that money? Rather than cleaning the air of another part per million of ozone, perhaps the funds could be spent for cleaning water, improving prenatal care or building safer highways. Would society benefit more from such expenditures than from forcing producers to clean the air just a bit better? We all want the cleanest air possible, but there is a limit to the amount of resources we would devote to that goal, given the variety of other goals we have.

illustration So, how clean is clean enough—what is the efficient level of pollution? Most economists view cost-benefit analysis as the best tool available for answering that question, for deciding what the true costs and benefits are for a given environmental policy and what tradeoffs exist in implementing it. What are the benefits gained by society for implementing a certain standard and what does it cost to achieve that standard? Would a higher or lower standard be better?

And of course, economists like to calculate at the margins. If society can spend one more dollar cleaning the air and save two dollars in health care costs because of lowered lung damage, it's money well spent. But if it costs two dollars to clean the air and saves just one dollar in health care costs, society as a whole has not benefited. Those two dollars might have yielded greater benefit if spent on medical research. The right standard, from an economist's standpoint, equates the marginal cost with the marginal benefit: the point at which net benefits (total benefits minus total costs) are greatest.

To prohibit analysts from considering costs in setting pollution standards—as the Supreme Court says Congress did in writing the Clean Air Act—is to create an economic scissor with just one blade. Not considering costs makes it impossible to determine an economically efficient level of pollution, and that indeterminacy is staggeringly troublesome to an economist.

Return to: Cost v. Benefit: Clearing the Air?

Douglas Clement
Senior Writer

Douglas Clement was a managing editor at the Minneapolis Fed, where he wrote about research conducted by economists and other scholars associated with the Minneapolis Fed and interviewed prominent economists.