Sunday, November 23, 2008

Why Neoclassical Theory is Important

All economists are well-versed in neoclassical economic theory, the theory where decisions are made at the margin and marginal values and costs slope downward and upward, respectively. The recent cow tax (discussed previously here) provides a perfect opportunity to demonstrate the usefulness of this theory.

The American Farm Bureau has announced that they oppose this tax because it would force some producers out of business (read more here). If the cow tax is based on any economic logic, it is supposed to force some producers out of business.

The basic idea is that the value of one more pound of beef to consumers declines the more beef you already have. It is like saying the first bite of a hamburger tastes better than the 100th bite. Conversely, the cost of greenhouse gases emitted from cows rises the more beef that is produced. At some point, the value of one more pound of beef becomes so low that it is less than the cost imposed by the greenhouse gases.

The solution is to produce less beef, to keep decreasing beef production until the value of each pound of beef produced is now higher than the environmental cost (and, of course, the production cost). To produce less beef, someone has to go out of business. The beauty of the cow tax is that it forces the least efficient producer to cease production. So if the cow tax is to produce benefits for society, if it is to correct the problem that some pounds of beef are valued less than the cost they impose, it must be high enough to force some producers out.

A final note: neoclassical economics asserts that this does not mean we should cease all beef production. As beef production falls, the value of each pound rises, and it will likely fall to some point where the value of beef is greater than the cost, even if beef still produces some pollution.

This post is written under the assumption that climate change is real and that small changes at the U.S. level have real benefits. I am not smart enough to know the correct answer to these two questions; I can only say I am open-minded and skeptical.

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