Social Norms and Private Actions: When asked to explain our actions, we sometimes simply respond by saying “it was the right thing to do.” The concept of “the right thing to do” is one that is often formed by observing others— and the more we see others “does the right thing,” the more we believe it is in fact “the right thing to do”. In such cases, my action “to do the right thing” directly contributes to the social norm that partially governs the behavior of others — and we therefore have an example of an externality.
A. Consider for instance the use of observably “green” technology—such as driving hybrid cars. Suppose there are two types of car-buyers: (1) a small minority of “greenies” for whom green technology is attractive regardless of what everyone else does — and whose demand for green cars is therefore independent of how many others are using green cars; and (2) the large majority of “meanies” who don’t care that much about environmental issues but do care about being perceived as “doing the right thing.”
(a) Draw a graph with the aggregate demand curve D0 for the “greenies.” Assume that green cars are competitively supplied at a market price p∗ —and draw in a perfectly elastic supply curve for green cars at that price.
(b) There are two types of externalities in this problem. The first arises from the positive impact that green cars have on the environment. Suppose that the social marginal benefit associated with this externality is some amount k per green car and illustrate in your graph the efficient number of cars x1 that this implies for “greenies”. Then illustrate the Pigouvian subsidy s that would eliminate the market inefficiency.
(c) The second externality emerges in this case from the formation of social norms — a form of network externality. Suppose that the more green cars the “meanies” see on the road, the more of them become convinced that it is “the right thing to do” to buy green cars even if they are somewhat less convenient right now. Suppose that the “meanies’s” linear demand D1 for green cars when x1 green cars are on the road has vertical intercept below (p∗ −k). In a separate graph, illustrate D1 — and then illustrate a demand curve D2 that corresponds to the demand for green cars by “meanies” when x2(> x1) green cars are on the road. Might D2 have an intercept above p∗?
(d) Does the subsidy in (b) have any impact on the behavior of the “meanies”? In the absence of the network externality, is this efficient?
(e) How can raising the subsidy above the Pigouvian level have an impact far larger than one might initially think from the imposition of the original Pigouvian tax? If the network externalities are sufficiently strong, might one eventually be able to eliminate the subsidy altogether and see the majority of “meanies” use green cars anyhow?
(f) Explain how the imposition of a larger initial subsidy has changed the “social norm”—which can then replace the subsidy as the primary force that leads people to drive green cars.
(g) Sometimes people advocate for so-called “sin taxes” — taxes on such goods as cigarettes or pornography. Explain what you would have to assume for such taxes to be justified on efficiency grounds in the absence of network externalities.
(h) How could sin taxes like this be justified as means of maintaining social taboos and norms through network externalities?
B. Suppose you live in a city of 1.5 million potential car owners. The demand curves for green cars x for “greenies” and “meanies” in the city are given by xg (p) = (D −p)/δ and xm(p) = (A+BN1/2 − p)/α, where N is the number of green cars on the road and p is the price of a green car. Suppose throughout this exercise that A = 5,000, B = 100, D = 100,000, α = 0.1 and δ= 5.
(a) Let the car industry be perfectly competitive, with price for cars set to marginal cost. Suppose the marginal cost of a green car x is $25,000. How many cars are bought by “greenies”?
(b) Explain how it is possible that no green cars are bought by “meanies”?
(c) Suppose that the purchase of a green car entails a positive externality worth $2,500. For the case described in (a), what is the impact of a Pigouvian subsidy that internalizes this externality? Do you think it is likely that this subsidy will attract any of the “meanie” market?
(d)Would your answer change if the subsidy were raised to $5,000 per green car? What if it were raised to $7,500 per green car?
(e) Suppose that a subsidy of $7,500 per green car is implemented and suppose that the market adjusts to this in stages as follows: First, “greenies” adjust their behavior in period 0. Then, in period 1 “meanies” purchase green cars based on their observation of the number of green cars on the road in period 0. From then on, each period n, “meanies” adjust their demand based on their observation in period (n −1). Create a table that shows the number of green cars xg bought by “greenies” and the number xm bought by “meanies” in each period from period 1 through 20.
(f) Explain what you see in your tables in the context of network externalities and changing social norms.
(g) Now consider the same problem from a slightly different angle. Suppose that the number of green cars driven by “greenies” is . Then the total number of green cars on the road is N =  + xm. Use this to derive the equation p(xm) of the demand curve for green cars by “meanies”—and illustrate its shape assuming  = 16,000.
(h) Relate this to the notion of “stable” and “unstable” equilibria introduced in exercise 21.8B (e). Given that you can calculate  for different prices, what are the stable equilibria when p = 25,000? What if p = 22,500 and when p = 17,500.
(i) Explain now why the $2,500 and $5,000 subsides would be expected to cause no change in behavior by “meanies” while a $7,500? would cause a dramatic change.
(j) Compare your prediction for xm when the subsidy is $7,500 to the evolution of xm in your table from part (e). Once we have converged to the new equilibrium, what would you predict will happen to xm if the subsidy is reduced to $2,500? What if it is eliminated entirely?