Friday, March 30, 2007

Externality misunderstood

We were about to take off. That guy sat right next to the window with emergency exit sign on it (and a red handle to open it). Then this stewardess came. She told the guy that because his seat was the closest to the exit, he needed to read the information on how to quickly act in case of emergency.

The guy asked the stewardess, "Do you think it is fair? Why is it me who should be the responsible passenger? I believe I paid the same fare with this man (he was pointing at me, who was sitting right in front of him)". The stewardess looked confused. She said hesitantly, "Ugh, Sir, it is the rule. We've been doing this ... ugh, forever". The guy insisted, "But, look. I don't care how long you have been doing this stupid rule, but if you want me to be the exit handle guy, you should pay me".

Alright, that's it. I stood up. "Dude, I guess you learned econ?". Yup, he said quickly. He said he is doing econ in one of those big name universities. "No wonder! Your argument is familiar to me," I said, "But you are ... wrong, dude".

So I spent the next three minutes humiliating him (OK, maybe I was trying to impress the poor but rather cute stewardess). I told him that in case of emergency, he has the biggest chance to get off the plane first. Compared to me and other passenger, he is relatively luckier. But we paid the same fare. Is it fair? Yes, I said. Because that guy also had to be the one who should read that information leaflet and who should pull up the handle. In other words his cost of assuming the responsibility cancels out his benefit of sitting in the supposedly safest place.

OK, I made the story up. But this could have happened in that Fokker 100.

Theoretically, the canceling out might not be perfect (i.e. the cost might be slightly larger than the benefit, or just the opposite). In such case he could have demanded payment from the rest of the passengers for his being the handle guy, and other passengers might have demanded payment from him to compensate for their relative disadvantages as far as seatings were considered. But the cost of managing all this transaction is prohibitively high. That's why it's not normal for passengers to negotiate seats among themselves.

You might say, hey, what if that dude is more risk taking, compared to others in the plane? That is, what if he values the safe seat less than other guys? That might happen. In this case, the best solution is actually to give any seat to the highest bidder. But again, transaction cost would be extremely high.

My point in fact is, don't be too quick in calling a problem an externality and demand a money compensation to 'internalize' it. Transaction costs might as well be too high, you don't want to 'internalize the externality'.

And again, I owe this to Coase (1960). I hope I got it right.


  1. apology upfront, but i think i still don't get it. are you suggesting that the passengers think in terms of fairness, transaction cost, and the likes?

    based on my flying experience: (1) the reason you want the seat right next to the emergency door (and also the seat adjacent to it) is because you want to relax, by having a better flexibility of, your leg; and (2) people don't negotiate over the seat near the emergency door not because the transaction cost is too high. it's because they don't believe they are going to have an accident.

  2. Tirta, I might be using bad example. But it was a fokker-100, Cityhopper -- all the seats are the same (as far as comfort level). You can't relax like if you were in big airbus/boeing.

    But by your airbus, that guy's logic is even more fallacious. He obviously shouldn't complain. He might even have to pay for that seat, net.

    As for what passengers really think of, I don't know. I was using that anecdotal guy to explain how people overlook the fact that externality is always reciprocal in nature.

  3. ah, i see. sorry for careless reading ;-)