Tag: externalities

the dominos effect.

When was the last time you flew low cost on a short haul trip? My flatmate is addicted to it and it doesn’t take a PhD in sciences to understand why. Firstly, it is 2 to 4 times cheaper than flying on a major airline. Secondly, what would you get by paying more on a major anyway? I mean what did major airlines become today? The last short haul flights I took on BA were no better than flying on EasyJet if it wasn’t for being assigned a seat, having relatively better looking stewardesses and a complimentary – yet disgusting – snack with my free soda. Yet I can remember flying on major airlines 10 years ago and it wasn’t like that. So what happened in between? Low cost airlines happened.

With a clever business model based on “no frills”, they became massively price-competitive against major airlines. One of their strengths was to target remote airports and cities that were ready to cut their costs down and to subvention the carriers on the basis that they were bringing a new flow of tourists in these areas. They’ve impacted their Industry and beyond. Firstly, they managed to open some new routes to tourists who could not have afforded it otherwise, which brought a lot of business to those targeted cities. You would therefore be right to see a positive side effect in low cost airlines but Majorca city doesn’t really see it this way, claiming that low cost travel actually brought a new type of tourists – and one from the lower economic tier of the population. Put it this way, budget airlines offered the poor the chance to fly like the rich and enjoy the same vacations, which resulted in the rich leaving to pastures new, and therefore not really benefiting these cities from that economic growth I was mentioning earlier. Another side effect is what budget travel did to major airlines, threatening their business, resulting in the latter finding ways to compete and also trending towards the no frills business model. Finally a – so-called – negative side effect of budget airlines is their impact on the environment. More flights mean more gas emissions that aren’t good for Mother Nature. “So-called” because aviation is only responsible for around 2% of all gaz emissions and that beef eaters (cows being responsible for 20% of these same emissions) should think twice before pointing to the sky.

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These side effects, whether they are desired/ controlled or not, have a name: externalities. 

A side effect or consequence of an industrial or commercial activity that affects other parties without this being reflected in the cost of the goods or services involved.

A good example is the LoJack as well spotted by Levitt and Dubner in Super Freakonomics. LoJack is a security device that can be hidden into a car and that will track that car – when stolen – via GPS whilst alerting the police. Very efficient but its prohibitive cost of $700 means there are only a few being used. Now, since a car thief can’t tell the difference between a car with and without a LoJack, he might think twice before stealing ANY car. This shows the very positive externality your rich neighbour had on the whole neighbourhood.

Now even though most externalities aren’t controlled, one can benefit from looking at the bigger picture when action on the market. Economist Keynes established a theory in which the government should be highly present in the economy of a country to ensure its growth. In a nutshell, he said that if the government, say, would decrease interest rates, and build good infrastructures to a city, then foreign investment would come, creating new businesses, diminishing unemployment, decreasing poverty and crime and so on. The virtuous circle. Most governments today are tackling unemployment by spending money on companies that are reluctant to hire, and job centres. Is this really the best solution? You can’t force a company to hire more people if there is no business growth to justify it. So why not spending money on that growth? Why not following Keynes’ theory? Externalities proved us that you can be more effective by looking beyond what the problem is. The dominos effect.

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