Economists do not operate in a vacuum. If an economist is going to suggest that the price of a good needs to be increased, he or she needs to consider who will bear the increase in costs. Will the costs be distributed equally or will one group pay more than another group? Furthermore, an economist should ask if there is a more efficient way to allocate the good than by means of a broad-based price increase. This lesson focuses on the drought that plagued the Northeast in the summer of 1999, supply, demand, and cost/benefit analysis.
Pop quiz, econ hot shot:
If you want to reduce the quantity demanded for a good, what do you do?
[Maybe A, Probably D. By this point, most economics students should be scratching their heads. The law of demand tells us that if the price of a good rises, the quantity demanded decreases. So, why is the better answer D?]
Economists do not operate in a vacuum. If an economist is going to suggest that the price of a good needs to be increased, he or she needs to consider who will bear the increase in costs. Will the costs be distributed equally or will one group pay more than another group? Furthermore, an economist should ask if there is a more efficient way to allocate the good than by means of a broad-based price increase.
For example, consider the drought that plagued the Northeast in the summer of 1999. For most of the season, water was scarcer than usual and local governments urged citizens to conserve water. The drought became very serious, as reservoirs dropped to record lows and farmers lost acres and acres of farmland. If water conservation was so important, why didn't water companies, the government, or another organization raise the price of water across the board in order to decrease the quantity demanded?
The policy of raising the price of water for everyone may impose more costs than benefits. Costs and benefits need to be weighed in more than fiscal terms. Imagine you are a policy advisor to New Jersey Governor Christie Todd Whitman. Her state was particularly hard hit by this summer's drought and she needs your help in deciding how to decrease the quantity of water demanded. Before you recommend any particular policy, however, you need to consider the four E's:
Equity: How equitable is the policy? Who will bear the costs of the policy? Will the costs be distributed equally? Will the people who must pay the costs be able to afford them? If they cannot afford the costs, will there be subsidies available to them? Does the policy discriminate against any particular group?
Environment: How will the policy affect the environment? Will it change the way people use natural resources? Does it provide incentives for people to be wasteful?
Economy: How will the policy affect the regional economy? Will it create or destroy large numbers of jobs? Will the area be able to maintain productivity?
Effectiveness: Will the policy be effective? Will the state be able to enforce the policy? What incentives do people have to comply with the policy? Does the policy conflict with any laws already in place?
Now that you know how to analyze a particular policy, Governor Whitman proposes to you four ideas that she hopes will solve the drought crisis in New Jersey. She wants you to report to her on the costs and benefits of each policy. Below is a brief explanation of each of her plans:
Broad-based price increase: The price of water for all consumers, residential and commercial, would triple.
Prohibit domestic outdoor water use: Residents face stiff fines for outdoor water use. They are not allowed to wash their cars, water their lawns, fill their pools, or use any water outside of their house.
Progressive tax structure for water pricing: How much you pay for water would depend on how much water you use. The first hundred gallons of water you use would only cost $.05 a gallon, the next hundred gallons would cost $.10 a gallon, and so on.
Voluntary water restrictions: People would be informed about the seriousness of the drought and the governor would request that people cut back their water usage. The policy would offer suggestions on how consumers could conserve water.
The governor is a busy woman. She wants you to think carefully about each plan, but she does not have the time to read a long brief. Therefore, she wants you to grade each policy according to four criteria: equity, environment, economy, effectiveness. Next, determine a final grade for each policy. The final grade does not have to be an average of the four grades, as one component may be weighted more than another. However, you must defend your choices.
Broad based price increase:
Equity_______________
Environment__________
Economy_____________
Effectiveness__________
Final_________________
Prohibit domestic outdoor water use:
Equity_______________
Environment__________
Economy_____________
Effectiveness__________
Final_________________
Progressive tax structure for water pricing:
Equity_______________
Environment__________
Economy_____________
Effectiveness__________
Final_________________
Voluntary water restrictions:
Equity_______________
Environment__________
Economy_____________
Effectiveness__________
Final_________________
The governor thanks you for your time and effort. She will make her decision based on the information you have provided.
Which policy would you like to see the governor pursue? Why do you think that that policy would be the best one?
Go to Remarks of Governor Christine Todd Whitman, Administrator of the U.S. Environmental Protection Agency to see what Governor Whitman of New Jersey decided to do during their water shortage.
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