cost

“cost” is defined as an amount that has to be paid or spent to buy or obtain something.

suppose you can buy a cookie at the local bakery for 3$. the cost of that cookie is thus, by definition, 3$. that’s what you pay to obtain it.

but what if you steal it? what is the cost of that negative externality? of course, it’s still 3$. the cost has nothing to do with whether you purchase it or steal it. internal vs external is orthogonal to cost.

but what about the cost of causing harm with no nominal price? for instance, what if you punch someone? in principle, it’s no different. the cost is whatever the person would charge you to voluntarily undergo that treatment. you would technically be “obtaining” the right to punch them in the face, so the “price spent to obtain something” definition still applies.

also note that it doesn’t matter whatsoever what the reason is for someone to accept a given price. suppose for instance that you key someone’s car. the cost for a local auto body shop to repair it, plus the cost of your time, is 200$. by this standard, the cost of the damage is 200$. but now suppose they tell you they’d accept 100$. what this means is that they would just pocket the money and not fix the damage, because there’s something else out there they’d rather have then an unblemished paint job.

but now suppose a new auto body technology is invented that can fix the scratch for merely 50$. in that case, the cost becomes only 50$. you might intuitively say, “wait, the cost is the harm you’ve done, not the price to fix it.” but remember, the cost is just the price at which that person would sell you the right to cause that harm. if it can be fixed for 50$, then this is the price at which you could obtain the right to key the car. and we can prove this via revealed preference. we could simply ask this person, “how much would you accept to let me key your car?” the answer would be 50$.

again, cost is just whatever price someone would charge you to let you obtain something from them. this is the definition of cost.

carbon

so then, what is the social cost of a negative externality such as carbon emissions? it is simply the sum of the cost to each individual. and as we just observed, the cost to an individual is just the amount of money that individual would charge you for you to obtain the right to subject them to a given amount of harm.

for instance, imagine i asked you how much i’d have to pay you for you to agree to let me release a 8 billion tons of carbon into the atmosphere. you say, “100 dollars”. then the cost to you of releasing that carbon is—by definition—100 dollars. the social cost would then just be the sum of that answer for every individual on earth.

sequestration

but now suppose a carbon sequestration technology is invented that removes carbon from the atmosphere for only 50$ per ton. this means that the cost to you of releasing that carbon is now merely 50$, not 100$. because you can just agree to have the government tax you 50$ to remove all that carbon. (8 billion tons times 50$ per ton, divided by 8 billion people in order to get your individual share of the cost.)

this is exactly like the auto body shop that can fix your keyed car for 50$. this new technology changes the price someone has to pay you to obtain the right to emit carbon that affects them.

conclusion

• internal vs external is orthogonal to cost. so the “social cost of carbon” (SCC) has nothing to do with the fact that it’s an externality.
• the cost of causing harm to someone is just the price they’d accept for allowing that harm. (you “obtain” the right to harm them.)
• it doesn’t matter whatsoever what the reason is for someone to accept a given price. you might accept a given price to be harmed by climate change because you live somewhere only mildly affected by it. or you might accept that price because it’s the cost to sequester that carbon back out of the air, thus neutralizing the harm. but the reason doesn’t matter. it’s an irrelevant implementation detail. all that matters is the price you’ll accept.