Question

Suppose you are the general manager of a local company that produces dry cleaning fluid.  Your company is located along a river in a community where the environmental laws are very lax and rarely enforced. However, the community believes very strongly about environmental issues.

The CEO comes up to you one day.  You admire his work ethic and he is a personable individual.  However, the company was inherited from his father and he has little to no business or practical experience.  

“We need to find a way to cut our costs,” he says.  “I know I’m new here, but profits are the difference between our revenues that we get from our sales, minus the costs we incur, right?”

You find now not the best time to distinguish between economic and accounting profit, but decide just to pay attention to the accounting profit for now.

“Yes, sir,” you respond.

“And our revenues are equal to the price people pay for our cleaner fluid, multiplied by how much they buy, right?” he asks.

“Totally,” you say.

“And our costs are all the expenses we incurred to produce the stuff, right?”

“Yes,” you say again, nodding affirmatively.  

“Well, I notice that 30 percent of our costs go to shipping our waste fluid in big containers. No one around here has ever gotten in trouble or fined for dumping the waste in the river.  Why don’t we do that?”

Put aside what you feel is right vs. wrong about this scenario. What might be economically wrong with this CEO’s thinking?  

Answer 1

Since this CEO is new to this business and has no knowledge of it(as mentioned in the story that he has inherited it),despite his knowledge of formulas to calculate revenue and costs he certainly lacks the knowledge of externaloexte that every business faces, though some may face positive externalities while others may face negative externalities.

Moreover,his idea of dumping waste fluid in the river is an example of the negative externalities.This is so because,dumping of waste fluid may lead to some harmful effects,that in long run may become an expense to the nearby area.