So I thought I might run through a brief lesson of what I have learned in higher education and how those principles apply to our everyday world. I graduated with a B.S. in Renewable Energy Economics and Policy, and I’m currently pursing a masters in Environmental Policy at the University of Michigan.
But this post is not about me. It’s about markets and how they function.
To set the tone, here’s some background etymology. Economics’ root word, eco, is derived from the Greek word Oikos–meaning household or family. Economics literally translates into “management of the household.”
In order for any family unit to properly function, certain rules are established in a home. Example: dirty dishes must be placed in the dishwasher or cleaned properly when used so the next user doesn’t have to do so. If not, extra chores might be assigned. Although this analogy might be a stretch similar protocol applies to markets.
Markets typically act as a mechanism to facilitate transactions between buyers and sellers while offering perfect information. Not all markets are created equally (some have many producers and are more perfectly competitive, while others act as monopolies with one buyer that exhibits significant market share). All markets, however, can generate costs or benefits that are not taken into account within the routine transactions. These costs and benefits can be placed on others not directly involved, making them pay or succeed just by being a by-stander. These costs and benefits I’m referring to are called externalities.
There are two types of externalities–positive and negative. The typical example of a positive externality is clean air (e.g. someone that cleans up the air can make society and ecosystems better off); the typical example of a negative externality is pollution (e.g. a firm placing the cost of clean-up or health-care onto society as a result of their manufacturing).

Economics informs us that the presence of negative externalities merits government intervention because that particular market has failed to function properly. These intervention mechanisms can include anything from a tax to thorough monitoring to other policies.
Most people would cringe at the thought of more government. I happen to agree. As a firm believer in the free market, I would also like to see less government intervention. How do we enable that? The answer is fairly intuitive–use fuels that inherently don’t require firms to internalize the cost for cleanup because the pollution is not an issue in the first place.
Fuels grown here in America such as ethanol and bio-diesel do not contribute to smog or air pollution. Therefore, they do not result in externalities that must be internalized.
It’s about time we start getting back to the academic principles to point us in a better direction of where we need to head as a society.