Chapter 16: Externalities

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Welcome to The Deep Dive, the show where we take a stack of sources and really extract the most important nuggets of knowledge to help you get well -informed, fast.

And today, we're diving into a topic that honestly explains so much of what's happening around us.

Yeah, everything from, you know, big debates over energy policy to maybe why your morning commute feels like a never -ending parking lot sometimes.

It's a concept that truly helps you understand the hidden ripple effects of our actions.

Take the ongoing discussion around fracking, for instance.

Right.

We see headlines about the economic benefits, like sure, lower energy costs, but then you also have concerns from studies, like one from Duke University, looking at potential groundwater contamination.

It's a classic societal trade -off, isn't it?

Where some benefit, but maybe others bear these unforeseen costs?

Exactly.

Or think about something we probably all experience, maybe even do sometimes, distracted driving.

Oh, yeah.

We know it's dangerous, right?

But why does it become a societal problem, not just, you know, an individual's bad habit?

Both of those, fracking's environmental side and the dangers of texting while driving, they're perfect examples of what economists call externalities.

That's right.

And our mission in this deep dive is to clearly unpack this idea of externalities, mainly using the microeconomics chapter by Krugman and Wells.

So you'll get a kind of shortcut to understanding how our decisions, whether individual or from firms, can impact others.

Yeah.

And why markets sometimes fail, that's the term they use, to account for these crucial effects, and importantly, what policies can step in to try and correct them.

And this isn't just theory for an economics exam.

Though it will definitely help you ace those.

Definitely.

But it's really about gaining powerful insights into the world around you.

Okay, so let's unpack this.

At its core, what is an externality?

Well, it happens when individuals or companies either impose costs or maybe deliver benefits to others.

But they don't have an economic incentive, like a price signal, to consider those benefits in their own decision making.

Think of it like a ripple effect the market doesn't automatically count.

Right.

A prime example of a negative externality is pollution.

Classic one.

So say a coal -fired power plant emits sulfur dioxide.

That contributes to acid rain, which can damage fisheries and crops,

maybe hundreds of miles away.

And the power company's business model doesn't usually include compensating the fishermen or the farmers for that damage.

Exactly.

The health costs people bear from breathing dirty air or the damage to ecosystems, those are just external costs, an uncompensated cost imposed on others.

And it's not just big industry, right?

Like you mentioned traffic congestion.

Yeah.

When you decide to drive during rush hour, your individual choice adds just a little bit more to the overall jam.

Making everyone else's commute that tiny bit longer and more frustrating.

And you don't directly pay a fee for that specific inconvenience you inflict on all those other drivers.

Or going back to driving.

Our source material highlights this as a pretty significant negative externality.

The stats are scary.

They really are.

Studies show a driver is something like 23 times more likely to crash while texting.

It's alarming.

And the National Safety Council estimates roughly one in four traffic accidents and maybe 10 % of fatal crashes are linked to cell phone use.

That's just sobering.

And the key insight here from an economics point of view is that the risk isn't just to the driver themselves.

Right.

It's a risk to their passengers, to pedestrians, other drivers on the road.

The driver isn't paying for these potential costs to other people.

That's the external cost right there.

Indeed.

But, you know, externalities aren't always negative.

We also have positive externalities.

Okay.

So the flip side.

Exactly.

These are benefits that individuals or firms confer on others, but without receiving compensation for it.

Like getting a flu shot.

That's a good personal example.

Perfect example.

You incur the cost, maybe a little discomfort.

Yeah, the jab.

But your roommates or your colleagues,

they benefit because you're less likely to spread the flu virus around.

And you don't get paid by them for providing that benefit, even though society as a whole is better off.

Or think about business.

When one firm innovates, develops some new technology or process, their new knowledge often spills over.

We call it technology spillover.

And it contributes to innovation by other firms too.

They don't capture all the benefits of that new knowledge.

So that's an external benefit to the wider economy.

Okay.

So to sum up this part,

external costs are negative externalities, like pollution.

And internal benefits are positive externalities, like the flu shot or knowledge spillovers.

And the crucial point is that both types lead to private decisions, what I decide to do or what a firm decides that are not optimal for society as a whole.

Right.

And that's a core reason why economists talk about market failure.

The market, left alone, isn't producing the best outcome for everyone.

Okay.

This brings us to an interesting point about negative ones like pollution.

You often hear people say the goal should be zero pollution.

Right.

It sounds intuitive.

But our sources, Krugman and Wells, they challenge that.

Think about it.

Most pollution is a side effect of activities that give us useful stuff.

Like electricity, food.

Exactly.

Even producing cleaner burning natural gas involves some level of pollution or environmental disruption.

So the question isn't really zero pollution.

It's more like what's the socially optimal amount of pollution?

Okay.

How do we figure that out?

Well, economists compare two things, the marginal social cost of pollution and the marginal social benefit of pollution.

All right.

Break those down.

Marginal social cost.

That's the extra cost.

Yeah.

The additional cost society bears from one more unit of pollution.

So think increased health problems, damage to buildings, environmental harm.

And this cost typically increases the more pollution there is.

Why is it increased?

Because nature's capacity to absorb or dilute pollution diminishes.

The first bit might not do much harm, but the thousandth ton does way more damage than the first.

Okay.

Makes sense.

Now, marginal social benefit of pollution.

That sounds weird.

How can pollution be beneficial?

It's a bit counterintuitive, like you said.

It's not that pollution itself is good.

It's the opportunity cost of avoiding that pollution.

Ah, okay.

So what we give up to stop polluting.

Exactly.

If you want to reduce pollution, you have to use scarce resources, money, labor, technology that could have been used to produce other goods and services people want.

So the benefit of allowing one more unit of pollution is the value of those other things we don't have to give up.

And that benefit usually decreases the more we pollute or rather it decreases as pollution levels drop.

Right.

The benefit of allowing more pollution decreases as pollution levels rise.

Or put the other way, the benefit of reducing pollution is high when pollution is high, but it gets smaller as we clean things up because it gets progressively more expensive to eliminate those last few units.

So if you were to graph this, you'd have the marginal social cost curve sloping upwards and the marginal social benefit curve sloping downwards.

I see.

And the sweet spot, the socially optimal amount of pollution isn't zero.

It's where those two curves cross.

Exactly.

It's the point where the marginal cost to society of allowing one more unit of pollution equals the marginal benefit society gets from the activity causing that pollution.

Or said differently, the cost of reducing pollution further would actually outweigh the benefit of doing so.

Okay.

So if that's the ideal Q optimal on the graph,

why does a market economy left to its own devices usually produce too much pollution way past that optimal point?

It really boils down to the incentive problem we mentioned earlier.

Their polluter doesn't pay.

The polluter only considers their private costs and benefits.

They don't have an automatic incentive to factor in the costs their pollution imposes on others, those external costs.

So they keep polluting as long as they benefit, even if the cost to society is way higher than their private benefit at that point.

That's it.

The market outcome, let's call it Q market, ends up being much higher than Q optimal.

At Q market, the polluter might find their marginal benefit is basically zero, but the marginal social costs could be enormous.

It's like there's a missed opportunity for a trade.

Society would be better off paying the polluter something to reduce emissions, but in a free market, there's no easy way for that deal to happen.

Well, sometimes private solutions can work.

This leads us to the Coase theorem.

Ah, yes, Ronald Coase, Nobel Prize winner.

His theorem basically says that look, an efficient solution can be reached, even when there are externalities, if the costs of making a deal are low enough.

Making a deal, like negotiating.

Yeah, negotiating, communicating, writing contracts, enforcing them.

We call these transaction costs.

If transaction costs are low, the parties involved can potentially bargain their way to the affiliate outcome, regardless of who initially has the property rights.

So the polluter and the people affected could theoretically strike a deal.

Potentially.

When individuals start taking these external effects into account in their decisions, we say they internalize the externality.

But what's the catch?

Because pollution is still a huge problem.

The catch is usually those transaction costs.

They're often not low.

Think about air pollution.

Right, affects millions of people.

Exactly.

How are millions of people going to negotiate a deal with thousands of polluters?

The costs of just getting everyone organized would be massive.

Same for greenhouse gases causing climate change.

The harm is global and dispersed.

So when transaction costs are high, especially with lots of people involved,

private deals like Coase described just become impractical.

That's generally the case.

And that's when government intervention starts to look necessary.

Speaking of costs, the data you mentioned earlier on electricity generation is really stark.

It is.

Our sources cite research showing that for coal -fired power, the hidden external costs, the health effects, the environmental damage, what they call total external costs or tech per kilowatt hour, are significantly higher than for natural gas.

Are much higher.

Significantly.

For coal, the tech can actually exceed the market value of the electricity produced.

Natural gas, while not perfect, is substantially cleaner in terms of these external costs.

Wow.

And it's interesting because these economic realities have started shifting the market, haven't they?

Even alongside policy changes.

Absolutely.

Our sources point out that by 2016, it was already cheaper in many places to operate existing natural gas plants than existing coal plants.

And by 2018, building new clean energy like wind or solar was sometimes cheaper than running existing natural gas plants.

So economics can sometimes drive change faster than policy, although policy can definitely accelerate it.

Precisely.

And when private solutions like coast bargaining fall short due to high transaction costs,

government intervention becomes the main tool.

The history of acid rain in the U .S.

is a good example.

What happened there?

Well, before the 1970s, acid rain from sulfur dioxide emissions, mostly from coal plants, was devastating forests and lakes in the Northeast.

Then came the Clean Air Act of 1970.

Which forced reductions.

Yes.

It imposed regulations, environmental standards on power plans to reduce emissions.

And it worked, to a degree.

Rainfall acidity declined significantly.

But economists argued there might be a cheaper way.

They did.

They argued that a more flexible, market -based approach could achieve the same environmental goals at a lower overall cost to society.

And a modified Clean Air Act in 1990 actually incorporated some of those ideas and proved quite successful.

So what are the main policy tools governments use for pollution?

Generally, there are three main types.

Environmental standards, emissions taxes,

and tradable emissions permits.

Okay.

First up, environmental standards.

What are those?

These are basically rules.

They specify actions producers or consumers must take.

Think catalytic converters required on cars or limits on how much pollution a power plant can emit per hour.

And they've had success.

Yes.

The Clean Air Act overall has been credited with reducing major air pollutants by over a third since 1970, even while the economy and population grew.

But what's the downside?

You mentioned inefficiency.

The main drawback is inflexibility.

A standard often requires every polluter to cut back by the same amount or install the same technology.

But some firms can reduce pollution much more cheaply than others.

A uniform standard doesn't take that into account.

So the total cost of achieving the pollution reduction is higher than it needs to be.

Okay.

So that brings us to option two.

Emissions taxes,

also called...

Peguvian taxes, named after economist Arthur Pigou.

Right.

How do these work?

Instead of a rule saying don't pollute more than X, an emissions tax makes polluters pay a tax for each unit of pollution they emit.

So it puts a price on polluting.

Exactly.

If you set the tax equal to the marginal social cost of pollution at that socially optimal quantity we talk about, QOptimal...

Uh -huh.

Connecting back.

Then it gives polluters a direct financial incentive to reduce emissions up to the point where the cost of reducing one more unit equals the tax.

They effectively internalize the externality.

And why is this potentially more efficient than standards?

Because it's flexible.

Firms that can cut pollution cheaply will do a lot of reduction to avoid the tax.

Firms where it's really expensive might choose to pollute more and pay the tax.

But critically, the tax ensures that the marginal benefit of polluting, which is the avoided cost of reduction,

ends up being equal across all polluters equal to the tax rate.

This gets you the desired total reduction at the lowest possible overall cost.

Makes sense.

You let the market find the cheapest way.

Can you use this for other things besides industrial pollution?

Absolutely.

Pigouvian taxes can, in theory, discourage any activity with negative externality, like taxes on gasoline to account for congestion and pollution, or taxes on cigarettes.

What's the main challenge with emissions taxes?

The biggest practical difficulty is figuring out the exact right level for the tax.

Estimating the marginal social cost of pollution accurately is really hard.

Set the tax too low, you get too much pollution.

Set it too high, you stifle economic activity unnecessarily.

Okay, that leads to the third policy.

Tradable emissions permits.

This is often called cap and trade.

Right.

This is another market -based solution.

How it works is regulators first decide on the acceptable amount of pollution,

the cap.

So they set the Q optimal, basically.

Ideally, yes.

Then they issue permits,

licenses to emit, that add up to this cap.

These permits can then be bought and sold among the CERMs.

So like a market for the right to pollute?

Essentially, yes.

Firms that have low costs for reducing pollution will find it profitable to cut their emissions way back, maybe even below their initial permit allocation.

And then they can sell their leftover permits.

Exactly.

They sell them to firms where reducing pollution is much more expensive.

Those firms find it cheaper to buy permits than to make drastic cuts themselves.

So like the emissions tax, this system directs the pollution reduction efforts to the firms that can do it most cheaply.

Precisely.

It achieves the target level of pollution efficiently.

And interestingly, the market price that emerges for a permit ends up creating the exact same incentive at the margin as an emissions tax set at that same price level.

If a permit costs $200 per ton, firms will reduce pollution as long as their cost of doing so is less than $200 per ton, just like with the $200 tax.

Has cap and trade worked in practice?

Yes.

Quite successfully in some cases.

The U .S.

program for sulfur dioxide, the main cause of acid rain, started in the 1990s.

It led to a huge reduction, about 91%.

And estimates suggest it was up to 80 % cheaper than if they'd used traditional command and control standards.

Wow.

80 % cheaper is significant.

Very.

And the European Union has a large carbon trading system, covering about 20 % of global man -made greenhouse gas emissions.

It's a major global market now.

So both emissions taxes and tradable permits seem more efficient than simple standards.

They use market forces.

They do.

They both put a price on pollution, forcing polluters to internalize the external cost, and they allow flexibility in how the reduction is achieved, leading to lower overall costs for society.

This efficiency seems absolutely crucial when you start talking about global issues like climate change.

That feels like the ultimate negative externality.

It really is.

It's global.

It's long -term.

And the impacts are incredibly widespread and potentially devastating.

Define climate change in this context.

We're talking about the changes in Earth's climate, primarily driven by the buildup of greenhouse gases like carbon dioxide, mostly from burning fossil fuels.

And the effects.

More extreme weather events, heat waves, floods, droughts, stronger storms,

rising sea levels, threatening coastal communities,

impacts on agriculture, potentially leading to crop failures,

spreading of diseases, and importantly, the burden often falls disproportionately on poorer countries that contributed least to the problem.

The economic costs sound enormous, too.

They are.

Some estimates, as mentioned in Krugman and Wells, suggest world GDP could be down 20 % by 2100 if climate change goes unmitigated.

The true cost of carbon emissions, accounting for future damages, was estimated maybe $5 ,100 per ton back in 2017 and projected to rise possibly to $400 per ton by 2050.

And the main driver is burning fossil fuels, coal, oil, natural gas.

Yes, that's the primary source of the excess CO2 in the atmosphere.

We've seen global temperatures rising, particularly sharply since the 1980s.

The graphs clearly show this upward trend.

But there are alternatives, right?

Renewable energy sources.

Absolutely.

Things like solar, wind, geothermal, hydropower.

They're considered clean energy sources because they don't emit greenhouse gases during operation.

And we've seen shifts in the energy mix, at least in the US.

We have.

Coal used to be king for electricity, nearly 60%.

By 2019, it was down to about 20%.

Natural gas use grew a lot.

And renewables also rose significantly, hitting around 23 % by 2019.

Crucially, the cost has come down.

Dramatically.

The cost of large -scale solar and wind power has plummeted.

Graphs showing the average cost of energy clearly illustrate this in many cases.

Wind and solar are now cheaper than building new natural gas plants, let alone coal.

Yet despite that, fossil fuels still dominate globally.

They did in 2018, accounting for about 85 % of global energy consumption.

It's partly a legacy thing the infrastructure has built around them, and partly because historically they were cheaper, especially for rapidly developing nations like China and India, needing vast amounts of energy.

So dealing with a global externality like climate change needs more than just domestic policies like taxes or cap and trade in one country.

Definitely.

What else is in the toolkit?

One key strategy is government subsidies for research and development, R &D, and clean energy.

To make renewables even cheaper and better.

Exactly.

Governments, including the U .S., have invested billions since the 80s to help kickstart innovation, drive down costs, and make clean technologies competitive.

Politically, subsidies are often easier to implement than taxes or regulations.

And because it's global, you need international cooperation.

Absolutely essential.

That's where multilateral agreements come in.

Things like the Paris Agreement, where nearly every country agreed to set emissions reduction targets.

It's difficult, requires constant negotiation, but necessary for a shared problem.

What about individual actions?

Do they matter?

They play a role, too.

Things like smart metering in homes to encourage energy conservation,

maybe higher gasoline taxes to nudge people towards more efficient cars or public transport, supporting public transportation infrastructure, and even dietary choices reducing meat consumption, for example, can lower your personal emissions footprint.

But you often hear the argument, mitigating climate change is just too expensive, it'll cripple the economy.

How do economists respond?

With cost -benefit analysis.

The IPCC, the big international body on climate science,

estimates that meeting the Paris Agreement goals might mean global consumption is, say, 3 % to 11 % lower by 2100 than it otherwise would be.

Okay, that's a cost.

It is.

But compare that to the cost of inaction, that potential 20 % hit to global GDP from unmitigated climate change.

Suddenly, mitigation looks like a pretty good investment.

And there are other benefits, too, right?

Co -benefits.

Huge ones.

Especially health benefits.

Remember, burning fossil fuels doesn't just release CO2, it releases other air pollutants that cause smog, asthma, heart disease.

Estimates suggest around 4 .6 million premature deaths worldwide annually are linked to fossil fuel air pollution.

Switching to clean energy could generate health benefits worth up to 5 % of global GDP.

So the argument that it's too costly seems less convincing when you factor everything in.

Especially when you also factor in the rapidly falling price of clean energy technologies.

This led to that remarkable 2019 statement by over 3 ,500 economists.

Including Nobel laureates, former Fed shares.

Right, a very broad consensus advocating for a carbon tax, where the revenue is returned to households as a carbon dividend.

They called it an indisputable show of support for the validity of the economics of climate change.

Okay, we spent a lot of time on the bad side effects, the negative externalities.

Let's flip the coin.

What about positive externalities?

Right.

These are the mirror image.

Here, the market, left alone, tends to produce too little of something good.

Because the person or firm producing it doesn't get paid for all the benefits they create for others.

Can you give us a concrete example?

A great one from the book is farmland preservation, particularly in New Jersey.

New Jersey.

It's the most densely populated state, isn't it?

Exactly.

Yet it still has a surprising amount of farmland.

A big reason is the state's green acres program, which essentially pays farmers subsidies to not sell their land to developers, but instead preserve it permanently as open space or farmland.

By 2016, they'd preserved over 680 ,000 acres this way.

Why would taxpayers vote to fund this?

What's the positive externality?

Well, preserved farmland provides lots of benefits to people who don't own the farm.

Things like scenic booty, access to locally grown fresh food, habitat for wildlife, and it also helps alleviate the negative externalities that come with more development, like increased traffic, strainer water supplies, more pollution runoff.

So the benefits spill over to the whole community.

They do.

Our sources cite studies suggesting that every dollar invested in these state land preservation programs returns maybe $10 in economic value through things like tourism, ecosystem services, and even increased property values for nearby homes, up by 16 % in some cases.

But without a program like green acres, what would happen?

The market would likely provide far too little preserved farmland.

Maybe even none.

Why?

Because the individual farmer bears the cost of preserving the land, primarily the lost opportunity to sell it for a high price to developer.

But the benefits, the scenery, the wildlife mostly accrue to their neighbors and the wider public who aren't paying the farmer for those benefits.

Exactly.

So the farmer's private incentive is just to sell to the highest bidder, the developer.

The market outcome, QMKT, might be zero acres preserved, even though the social benefit of preservation MSB is very high.

So just like we use a Puguvian tax for negative externalities, we can use a Puguvian subsidy for positive ones.

A payment to encourage the activity.

Right.

An optimal subsidy, set equal to the marginal social benefit at the socially optimal quantity, QOPT,

can encourage farmers to preserve the right amount of land.

New Jersey's program is essentially doing this, paying farmers for the external benefits their land provides.

That's a great illustration.

Moving beyond farmland, what's maybe the most important positive externality for economic growth?

Arguably, it's the creation and spread of knowledge.

Technology spillovers again.

Yes, technology spillovers are huge.

Think about fundamental breakthroughs in areas like computing, AI, bioengineering.

The knowledge spreads, gets built upon by others, leading to waves of innovation across many industries.

And this happens in places like research clusters.

Exactly.

Places like Silicon Valley or the research triangle in North Carolina where universities and companies are geographically close.

This proximity fosters collaboration, competition, and the rapid exchange of ideas.

Lots of positive externalities flying around.

And this is why governments heavily subsidize universities and basic research, right?

Precisely.

Policymakers understand that knowledge creation generates massive external benefits that are crucial for long -term economic prosperity, benefits that private firms might not capture on their own.

There's another powerful example of positive externalities mentioned, early childhood intervention programs.

Oh, absolutely.

These programs, providing high quality education, healthcare, and support for disadvantaged young children and their families.

They can be incredibly effective at breaking intergenerational cycles of poverty.

What are the external benefits?

The children who participate tend to do much better later in life.

They have better health, are less likely to be involved in crime, more likely to graduate high school, get better jobs, pay more taxes.

So benefits accrue not just to the child, but to society as a whole.

Lower crime costs, higher tax revenues, a more productive workforce.

Exactly.

The social returns are often massive.

Studies cited show returns ranging from $4 to $7, sometimes even up to $17, in societal benefits for every $1 invested in high quality early childhood programs.

That is a huge positive externality.

Wow.

Okay.

Let's shift gears a bit to a different but related kind of externality that's super relevant in our digital age, network externalities.

Right.

A network externality exists when the value of a good or service to an individual user increases as more people use that same good or service.

The classic example is the telephone, right?

One phone is useless.

Two are a little useful.

Millions are incredibly valuable.

Perfect example.

Yeah.

And it applies to so much more, especially communication technologies, the internet itself, emails, social media platforms like Facebook or TikTok.

The more people on the network, the more valuable it is for everyone.

Exactly.

But it's not just tech.

Think about the early days of cars.

The more people who bought cars, the more incentive there was to build gas stations and better roads, making cars more useful for everyone.

Or online marketplaces like eBay, more buyers attract more sellers and vice versa.

Or even bank ATMs.

Sure.

The more customers a bank has, the more ATMs it can support, making the bank more convenient for all its customers.

But tech is where we see it most strongly today, perhaps, like computer operating systems.

Definitely.

The book uses the example of Windows versus Apple's Molance.

For a long time, Windows dominated desktops and laptops.

Why?

Partly network externalities.

How so?

Two ways.

There's a direct effect.

If most people use Windows, it's easier to share files and get help from other Windows users.

And there's an indirect effect.

Because Windows had such a large market share early on, more software developers wrote programs for Windows, making it more useful, which attracted more users, and so on.

It's a loop.

This leads to what they call positive feedback, or a bandwagon effect.

Exactly.

Success breeds greater success.

Failure breeds further failure.

In markets with strong network externalities, the product that gets the largest network early on often tends to dominate, sometimes locking out competitors, even if their product is technically just as good, or maybe even better.

And companies know this, so they strategize around it.

Oh, absolutely.

A common strategy is to try and build network size quickly, even if it means selling the product very cheaply, or even giving it away initially.

Like Skype offering free calls, or WhatsApp, or web browsers like Chrome and Firefox being free.

Precisely.

Get the users first, build the network, and then maybe figure out how to monetize later, or use the network dominance to sell other products or services.

Microsoft bundling Internet Explorer with Windows for free back in the day was a classic example of leveraging network effects.

But this tendency towards dominance creates problems for antitrust regulators, doesn't it?

It poses a real challenge.

Antitrust laws are generally aimed at preventing monopolization actions taken to unfairly crushed competition, rather than just the existence of a monopoly itself.

But if a company becomes a monopoly almost naturally because of strong network externalities, where's the line between legitimate success due to a popular product and illegal monopolistic behavior designed to maintain that dominance?

It's tricky.

The big Microsoft antitrust case back in 1998 really grappled with this, didn't it?

It did.

Microsoft clearly had a dominant position with Windows, largely due to network effects.

The U .S.

Justice Department didn't really challenge the Windows monopoly itself.

But they challenged how Microsoft was using it.

Exactly.

The core allegation was that Microsoft was illegally leveraging its Windows dominance to give its other products, particularly the Internet Explorer web browser,

an unfair advantage over rivals like Netscape Navigator, thereby stifling competition and innovation in related markets.

Microsoft argued they were just competing hard and innovating.

Right.

They essentially said the government was trying to punish success.

What was the outcome?

It ended with a consent decree in 2002.

Microsoft wasn't broken up, but they agreed to certain restrictions on their business practices, like not retaliating against PC makers who installed non -Microsoft software and sharing technical information so rivals' software could work better with Windows.

Did it have a big impact?

That's debated.

Some argue the tech landscape shifted so much towards the Internet and mobile anyway that the decree didn't matter much long term.

Others think it did make Microsoft more cautious about throwing its weight around.

But there were some clear effects.

Two undisputed effects, according to Krugman and Wells.

First,

it cemented the idea that products with strong network effects, like browsers, would often be priced at zero.

Second, it set a precedent, and now you routinely see rival tech giants accusing each other of using their network advantages in potentially anti -competitive ways.

The debates continue.

This whole discussion about innovation, costs, and market shifts brings us nicely to our final business case example.

Excel energies push into renewables.

Right.

We talked about how renewable energy costs have come down.

Historically,

though, renewables like wind and solar relied heavily on government subsidies to compete with cheaper fossil fuels.

And those subsidies can be politically uncertain, right?

Sometimes renewed, sometimes not.

Exactly.

But despite that uncertainty, the CEO of Excel Energy, Ben John Fouke, made a really bold commitment.

Excel operates across eight states, and they pledge to get 60 % of their electricity from renewables and achieve an 80 % reduction in carbon emissions by 2030.

How can they commit to that if subsidies might disappear?

Are renewables cheap enough now, on their own?

That's the key point.

They're leveraging the learning curve.

This is the idea that as a new technology gets adopted and produced at scale, companies figure out how to make it better and cheaper through experience and innovation.

It's a virtuous cycle.

We saw that with solar and wind prices.

Traumatically.

Solar panel prices fell over 75 % between 1998 and 2018.

Wind energy got over 90 % cheaper between 1980 and 2018.

The learning curve has been incredibly steep.

So where does that leave Excel now?

It means the cost competitiveness is undeniable.

The case study highlights that it's now often cheaper for Excel to build new wind turbines than it is to simply continue operating its existing coal plants.

Cheaper to build new than run old.

Wow.

Yeah.

Wind power can be acquired for maybe $15, $20 per megawatt hour, while even efficient natural gas might be $25, $35.

So Excel isn't just relying on subsidies.

They're making hard -nosed economic decisions based on the new cost realities.

And this competition keeps driving improvement.

It does.

The renewable sector knows it has to keep innovating to stay ahead, as fossil fuel technologies also try to improve, or as policies change.

It's a dynamic market.

So as we wrap up, it's clear that understanding these different kinds of externalities, negative ones like pollution, positive ones like knowledge billovers or preserved farmland, and these unique network externalities in tech.

It really helps explain so many real -world phenomena, from environmental problems and policy debates to why certain technologies dominate and how companies compete.

It gives you a framework for analyzing why markets sometimes succeed and sometimes fail, and what kinds of solutions, private or public, might make things better.

It truly is a fundamental concept.

We hope this deep dive has been a valuable resource for you, whether for your studies or just for understanding the economic forces shaping our world.

And here's a final thought to mull over.

As technology keeps evolving at lightning speed and global challenges like climate change or maybe pandemics intensify, how might the nature of externalities themselves change in the future?

And what new economic tools or ways of thinking might we need to develop to address them effectively?

Something to think about.

From the entire Deep Dive team, thank you for joining us on this exploration of externalities.

Thanks for listening.