Mind your Business - 29 September 2003
Opportunity Cost; Externalities and Alcohol Use
The News
| On the 19th September 2003, the Prime Ministers Strategy Unit published a report on the costs of alcohol use in the UK. The UK as a whole does not drink more than many of our European neighbours - indeed we appear to be 12th out of 19 major European Countries and the United States. What does appear to be a problem is the way in which we drink and the consequences of this type of behaviour. Binge drinking - consuming alcohol rapidly with the intention of getting drunk quickly - is on the increase particularly amongst the younger age groups. The consequences of the use and abuse of alcohol are frightening; indeed the figures are often so large that they become difficult to comprehend. The overall cost to the nation is estimated at being between £18 and £20 billion pounds (£18,000,000,000!). The costs are varied; there are 1.2 million incidents of alcohol related crime; the cost of alcohol related crime comes in at nearly £1.5 billion; the cost of the consequences of alcohol related crime is estimated at just over £8 billion. These costs are the cost of fines, solicitors used to defend prosecuted cases, increased insurance premiums, payments for medical treatment and so on. The costs associated with drink driving come to £525 million The cost to the Criminal Justice System to deal with those who are processed through the legal system on drink related crimes is £1.6 billion. Crime is not the only consequence; the National Health Service (NHS) is often the organisation that has to deal with the results of our drinking behaviour. Accidents caused by alcohol result in 150,000-hospital admission every year; 40% of admissions to Accident and Emergency (A&E) units are drink related. This figure rises to a staggering 70% between the hours of midnight and five in the morning. There are around 22,000 deaths attributed to drink related illnesses every year and the number of young people being affected by alcohol related diseases such as sclerosis of the liver is rising rapidly. The cost to the NHS is around £1.7 billion. There is then the cost to the economy at large - Working days lost due to absence from work attributed to alcohol abuse is between 11 million and 17 million costing between £1.2 billion and £1.8 billion. The figures for lost output as a result of premature death through alcohol related illness ranges between £2.2 and £2.4 billion and the overall cost to employers of lost productivity is around £6.4 billion. |
Theories
The main theory here centres on opportunity cost and externalities. Opportunity cost is the cost expressed as the next best alternative foregone.
Externalities are the costs and benefits to a third party of a decision by another.
Opportunity cost is a very important concept; its importance lies in the fact that we can assess the consequences of decision-making when faced with choices.
Sometimes these choices are forced upon us - for example, if I am in A&E with one of my children who has some injury or illness, I may have to wait longer for my child to get treatment if somebody is admitted who has been involved in a fight through some drink related incident and needs more urgent treatment.
The opportunity cost to the economy as a whole of the decision by someone to not go into work because of a hangover is the lost output that that person could have produced. If the NHS are spending £1.7 billion on treating patients because of some alcohol related problem that is £1.7 billion that is not available for treating those who need cancer treatment, fertility treatment, treatment for heart disease or whatever.
So, next time you are put on a waiting list for treatment and think it is a disgrace that you have to wait so long remember back to this concept. Opportunity cost helps us to reflect on the values we place on decisions. In general, economists would assume that people behave rationally. We will make our decisions between scarce resources on the basis of the degree of utility derived from its consumption. If we choose to part with our limited income on good x rather than good y it suggests we value good x more than good y. Of course in reality, the decision may be based, not on utility, but moral necessity. Many doctors in A&E units this weekend may well feel, deep down, that the drunken wreck who has fallen over and broken their nose, is hurling abuse at the doctors and nurses and who has vomited over their clothes and those who are trying to help them, they would rather treat the quiet and sober elderly gentleman in the waiting room, who has a small fish bone stuck in his throat!
Externalities can be either positive or negative. In this example we are going to look at the negative externalities that arise from alcohol abuse. As mentioned at the head of this section, the important thing to remember about externalities is that they are effects which are borne by individuals or organisations not related to the decision maker. Thus, in the example above, the third party could be my child who is prevented from getting treatment quickly because of the actions of the person involved in the fight. In this area we need to distinguish between the private and the social costs of the effects of alcohol.
The private costs are those borne by the individual, organisation or business themselves. The obvious private costs of a nights drinking would be the money that you get through! The private costs in this case can also be much greater and more widespread than just the cost of the drink. Should a person get into difficulties because of alcohol abuse - for example fights, crime or health issues, then that person may incur certain other costs such as legal fees to be represented by a lawyer, higher insurance costs if you have a conviction for a drink driving offence, the cost of having to get public transport rather than using the car if you were banned, the cost of medication and treatment for some types of medical care and so on. The social costs, however, are those that are borne by society as a whole. The cost of the policing of City Centres at the weekend is extensive. Police time spent dealing with crime and violence associated with alcohol means that they cannot be dealing with other crimes or working on helping to prevent crime. In central Nottingham for example, around twenty police patrol cars are on duty in the City Centre on a typical weekend night, the communities surrounding the City Centre therefore are not going to be able to have the benefit of patrol cars monitoring these outlying areas. As a result, smart criminals know that the chance of being caught is relatively low. Householders who are burgled in such circumstances face not only the emotional trauma of having their homes 'invaded' but also invariably face higher home insurance premiums, pay out money to buy burglar alarms, extra security on their homes and have to replace stolen items.
The cost related to lost days at work can be estimated using the concept of the Marginal Revenue Product (MRP). The MRP is the value added by the last unit of labour employed. It is found by multiplying the output produced by the last unit of labour by the price the product sells for: MRP = Marginal Physical Product (MPP) x Price(P) ) If a worker normally produced 50 items of a product per day and those products sold for £30 each, the MRP would be £1500. If the worker therefore did not turn up for work, the loss to the business would be £1500 worth of lost output! Estimating the cost to employers of lost days can also be estimated using the wages paid to workers. The employer pays a wage in return for the value of the output produced by the worker. A worker has the day off because of a hangover, they would normally be paid £60 per day, most workers would still receive their pay but the employer gets no return from the wage paid.
One of the major problems in using these techniques to estimate the cost is how to quantify the figures. How do we measure the cost of police time? How do we measure the cost of the emotional trauma involved when a drink driver injures a family member? How do we place a value on the emotional scars suffered by children who are abused by parents who are suffering from alcohol dependency or who witness the domestic violence that is all too often fuelled by alcohol. In reality it is very difficult. But in order to make policy decisions and to recognise the importance of dealing with such issues attempts do have to be made to quantify them So, estimating the wage bill of social workers who are involved with families who suffer problems brought on by alcohol could be one way of quantifying the emotional trauma suffered. Of course, in reality such trauma may be unquantifiable. But, if we can estimate that the cost of dealing with such problems it may help to make decision making on future expenditure programmes more informed.
For example, the current expenditure on alcohol help problems is around £100 million - not a small sum by any means. But, the amount spent by one company in promoting its new range of alcopop was £250 million. If the government were to announce an increase in spending on treatment centres for those suffering from alcohol related problems of £2 billion pounds, there might be an outcry that money was being wasted because people bring these problems on themselves - no one forces us to drink after all!. But if it could be shown that this spending would reduce the social and private costs of alcohol problems as a result by £6 billion then it would represent a very sound investment. The balance of £4 billion is released to deal with other problems and issues that would not have been dealt with before the spending! Now do you get the idea of opportunity cost?
Data, Facts and Figures
The following diagrams, charts and tables have been reproduced with the kind permission of the Strategy Unit, 4th Floor, Admiralty Arch, The Mall, London SW1A 2WH. From the report 'Alcohol Misuse: How Much Does It Cost?' [Published in September 2003 and available from http://www.number10.gov.uk/files/pdf/econ.pdf].
Source: http://www.number10.gov.uk/files/pdf/econ.pdf page 4
Source: http://www.number10.gov.uk/files/pdf/econ.pdf page 11 - a larger version is also available.
Source: http://www.number10.gov.uk/files/pdf/econ.pdf page 17 - a larger version is also available.
Source: http://www.number10.gov.uk/files/pdf/econ.pdf page 59.
Questions
- Look at the table above; choose three of the sections and explain how the reports authors may have valued the costs identified. (9 Marks)
- Chart 7 provides a chart highlighting the relative costs and benefits of alcohol use in the UK. How might such a chart contribute to the debate on the solutions to the problems posed by alcohol abuse in the UK? (9 Marks)
- Identify 3 possible strategies to help reduce the costs to individuals and society of the problems of alcohol misuse. Evaluate the strengths and weaknesses of your strategies. How would you quantify your strategies to allow the authorities to make informed choices about the effectiveness of different strategies? (20 Marks)
- Present an argument for one strategy that you think would be the most effective in reducing the problems highlighted by the report. Why did you choose to focus on the area concerned and why is this the most important reason for reducing the costs concerned? (12 Marks)
Related Web sites for research
- Alcohol Misuse Interim Analytical Report: http://www.strategy.gov.uk/work_areas/alcohol_misuse/interim.asp
- Alcohol Misuse: How much does it cost?: http://www.number10.gov.uk/files/pdf/econ.pdf
- ONS Data on alcohol: http://www.bized.co.uk/dataserv/ons/data/data.htm#3
Mark Scheme
The following is a guide to how you might go about structuring your answers:
- The aim here is to get you to think about the problems associated with valuing costs and benefits associated with externalities. For example, if you chose to use 'ambulance services' as one of your sections, how would you have arrived at the value of £205 million? What problems might there be with making the valuation? The intention is that you think carefully about these issues - there may not be a right or a wrong answer but it is important to understand some of the strengths and limitations of trying to quantify such information so that decision making can be informed. The report itself does give some background information about how and why they valued factors as they did - this might give you some valuable clues as to how economists think and work. Marks - 3 for each section, so look to give a bit of development or reasoning for your answer.
- The chart suggests that the private and external benefits of drinking are far outweighed by the number of private and external costs! In theory, this would suggest that we should take some serious action against drinking; possibly introducing a ban or tightening legislation; increasing the age at which alcohol can be bought and consumed?? However, we also need to take some account of the relative importance of the factors identified. How many people does this problem apply to? It may be that the vast majority of people who drink do so responsibly and get a great deal of utility out of the activity - is the value of this section of the community greater than the sum of all the negative parts? The inclusion of the word 'debate' in the question does draw you towards thinking of the balance that is needed in the argument. For 9 marks here you are expected to look at a couple of solutions at least and comment on the likely effectiveness given the information in the chart. In simple terms you could argue that to cut the negative external costs of alcohol that we should just declare it illegal - but that has been tried before in the USA in the 1920s and look what happened there!
- This question leads on from the last and now expects you to come up with 3 possible solutions to the problem. You are then expected to comment on how effective these solutions would be through analysing the strengths and weaknesses of them. Analysing means identifying the key factors that contribute to an understanding of the strategy as a whole in this respect. In addition, you are expected to comment on how you might quantify your strategy - you do not need to come up with actual figures but will be expected to show an understanding of the process by which economists arrive at quantifying what is often the un-quantifiable! (There is a very interesting discussion of this very topic in John Sloman's book 'Economics'; Prentice Hall. ISBN 0-13-568056-5 in the section on Cost Benefit Analysis entitled 'What Price a Human Life'? (3rd Edition, p346) ) This is worth 20 marks - 3 will be for identifying an appropriate solution; a further 9 marks will be for the analysis of your solutions strengths and weaknesses and the remaining 8 will be for the quality of your evaluation of the strategies including the discussion on quantifying the information.
- Question 4 now leads you to having to make one choice - it may be the choice you have made is focussed on reducing the problems associated with the effect on the workplace, or maybe you have decided to focus your attention on the policing or on the health care aspect. Whatever you have chosen you must demonstrate an understanding of opportunity cost here by comparing the cost of the solution with the possible benefits that will be gained and how this therefore changes the relative opportunity costs of the issues raised - see that last couple of sentences on the 'theory' section above for some hints here! There is a good deal of evaluation here so you must ensure that you frame your argument carefully and that you support your judgements.