Here is a question from the final exam for my public finance course:
A typical person’s demand for potato chips is given by p=5-q where q=the number of packages of chips purchased, and p is the price of chips in dollars per package. The marginal cost of producing potato chips is $1 per package. The potato chip market is competitive, so p=MC. Dr. Economides estimates that each package of potato chips consumed creates marginal damage of $0.50.
- Illustrate these facts with a diagram.
- Define the phrase “Pigouvian tax”
- Show how a Pigouvian tax could be used in this example to improve efficiency.
- Calculate the revenue raised by the Pigouvian tax. Show on your diagram, and calculate, the efficiency gain created by the tax.
- Opponents of the tax on potato chips take a careful look at Dr. Economides’ study. It turns out that the only people harmed by potato chip consumption are potato chip eaters themselves, as potato chip consumption is associated with bad skin, weight gain and depression. Does this strengthen or weaken the argument for taxing potato chips?
Solutions to parts 1 to 4 are here. The interesting part is question 5: if potato chips only harm potato chips eaters, does that strengthen or weaken the case for taxation? Vote here to express your opinion (only the first 200 answers will be counted).
The potato chip example, however, is different: the chip eater in the exam question isn't harming other people. The bad skin, weight gain, and depression is experienced by the chip eater himself. It is not obvious that a Pigouvian tax is needed to make chip eaters take into account the harms that they causing - why not just tell people that potato chips cause bad skin, and if people think the chips are worth the zits, let them munch away? They're only harming themselves.
Interestingly, a few of my students thought that this additional information about who is harmed by potato chip eating strengthened the case for imposing Pigouvian taxes.
Why is that?
One possibility is that the students were inadequately taught, or simply didn't study the material.
Some students disputed the basic premise of the question, the idea that potato chip eaters are only harming themselves. Bad skin, weight gain and depression, they argued, are harms to others, because we have a public health system. Yet the starting point for the analysis is that potato chips create damage of $0.50 per package. If chip eaters take any of any of that damage into account when making chip purchasing decisions, the case for taxing chips weakens. Also Canada's public health system often does not cover skin creams, anti-depressants and counselling, so the link between bad skin and depression on the one hand, and health care spending on the other is not obvious.
What interested me about this response was how "health" becomes a lens through which public policy issues are viewed, and a justification of policy choices. Perhaps, though, the students were just mislead by the wording of the question. Guessing that the specific details about bad skin, weight gain and depression must matter in some way, they figured that the question must be asking about health care.
Finally, it seems that some students really don't believe that people are rational decision-makers, fully taking into account the long-term effects of their consumption choices. Even when people are only harming themselves, they support Pigouvian taxes on paternalistic grounds, to stop people from harming themselves.
Today's Chronicle of Higher Education has an article arguing that mainstream economics is dominated by a "free-market fundamentalism," one tenet of which is that people are rational decision-makers. While this may be true, it's far from obvious that mainstream economists are successful proselytizers, bringing others around to their way of viewing the world.
Update: 62 responses to the survey so far, 87% have responded "weaken".