Nova workboard

a blog from young economists at Nova SBE

Driving Speed as an Externality

 

We often notice how many drivers tend to disrespect speed limits, while the existence of these limits means the State wants drivers to abide by them. This disparity can be seen as an externality, which arises when actions taken by one agent affect the welfare of others, without this being reflected in the decision of the former.

In general, drivers face a trade-off between safety and speed. Since the same increase in speed is more significant the lower the speed level, marginal private benefit (MPB) of speed is decreasing. Regarding marginal and social private costs (MPC and MSC), we can consider a positive slope. This can be justified by the fact that increasing speed not only increases the likelihood of an accident to happen, but it also increases the severeness of such an accident, in the event that it happens.

 

 

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The socially optimum level of speed is S*, where MPB = MSC. However, if there is no mechanism to correct the externality, the driver will choose S1, where MPB = MPC. Since S1 is different from S*, there is space for intervention. The goal here will be to make it more costly for drivers to overspeed. Ideally, the State should try to increase the MSC by the amount necessary to make it equal to the MPB at the socially optimal level of speed. Graphically, this means an increase in the MPC curve slope. There are several ways to achieve this, and they may be complementary to each other. Two of the most relevant will be explained.

First, by imposing a speed limit that reflects the socially optimal level, and imposing fines to those that do not respect this limit, the State can significantly increase the MPC for users that exceed the limit and, with this, deter them from doing so. For this to be effective, the value of the fine, adjusted to the probability that drivers expect to be caught in an infraction, has to be high enough so that it exceeds the marginal benefit of exceeding the limit. In general, the effectiveness of this method will increase with the fine value and with the number of speed controls. Since what matters is how drivers perceive the frequency of controls to be, it makes sense that law enforcement authorities tend to advertise increases in controls. (example here, in Portuguese).

Another way to reduce speeding is caused by incentives that insurance companies have to make their clients drive safer. An insurance contract opens way to moral hazard, i.e., since the insurance company cannot directly observe the actions from the driver, he has an incentive for being less careful than he would otherwise. The role of insurance companies in reducing excessive speeding is through the design of contracts aimed at reducing this moral hazard. Everything else constant, insurance companies will want drivers to reduce the risk they take. While their goal is not necessarily to bring drivers to the socially optimum level, they want to increase driver’s perception of the MPC, so their actions will result on a reduction of driving speed.

To sum up, if we think of speeding as a negative externality, actions should be taken to make its value closer to the socially optimal. While there are different ways to do this, all of them can be translated as an increase in the MPC of speeding, so the goal is for consumers to internalize the externality in their decision making process.

 

João Araújo no. 638

 

 

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Author: studentnovasbe

Master student in Nova Sbe

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