Why economics is not a morality tale

Ex­am­ple nicked from this on­line Berkeley lec­ture.

Mo­nop­o­lies are bad (moral­ity and eco­nomics agree here).

Firms that pol­lute are bad (moral­ity and eco­nomics agree here).

What about mo­nop­o­lies that pol­lute?

What about strong mo­nop­o­lies that pol­lute and re­ceive gov­ern­ment sub­sidies?


Pol­lu­tion, and other nega­tive ex­ter­nal­ities, cause firms to pro­duce too much of their product. That’s be­cause they don’t pay the full cost of the product, in­clud­ing the im­pact of pol­lu­tion.

The equil­ibrium be­havi­our for mo­nop­o­lies is to pro­duce too lit­tle of their product, to keep prices and prof­its high.

So a monopoly that pol­lutes is sub­ject to two op­po­site ten­den­cies: the un­priced-pol­lu­tion ten­dency to pro­duce too much, and the mo­nop­o­lis­tic ten­dency to pro­duce too lit­tle. If the effects are of com­pa­rable mag­ni­tude, then the monopoly might be much closer to so­cial op­ti­mum than a free mar­ket would be (the so­cial op­ti­mum, in­ci­den­tally, will gen­er­ally in­volve some pol­lu­tion: we need to ac­cept some pol­lu­tion in the pro­duc­tion of fer­til­iser, for in­stance, in or­der to have enough food to stop peo­ple starv­ing).

In fact, if the mo­nop­o­lis­tic effect is too strong, then the firm may un­der-pro­duce, even taken the pol­lu­tion effect into ac­count. In that case, we can ap­proach closer to the so­cial op­ti­mum by… sub­si­dis­ing the pol­lut­ing monopoly to pro­duce more!!

And that, my friends, is why eco­nomics is not a moral­ity tale.