The U.S. government subsidizes flood insurance because those who want to buy it live in the flood plain and cannot get it at reasonable rates. What inefficiency does this create?
Frequent flooding of the Mississippi River in the 1960’s significantly drove up the federal disaster-relief programs costs. The National Flood Insurance Program (NFIP) was introduced by Congress to provide flood insurance to the public to communities which adhere to specific city planning set forth by FEMA. The program was successful at providing flood insurance at reasonable rates but it was criticized by many who believed that the program encouraged imprudent building in flood zones.
We have learned that subsidies destroy wealth by allowing lower-valued consumers to buy higher valued assets. The environmental costs of building in such areas when added to the actual cost of subsidization are far greater than the gains of the subsidy.
Furthermore, without these subsidies tax money would have been spent on higher valued uses. Congress has typically set the flood insurance rate too low effectually subsidizing building in flood areas at taxpayers expense.
Hurricane Katrina and other storms have put the program in debt by $19 billion dollars. FEMA has recently redrawn their flood maps. People who previously thought they were outside of the flood zone are now learning that they are in flood prone areas. Mortgages typically require homes in high risk flood zones to have mandatory flood insurance. A home may have been grandfathered in to be exempt of the new zoning but this will become a nightmare if you decide to sell.
What may have previously cost you several hundred dollars a year may cost a new buyer several thousand a year. One a potential buyer hears that news they may bail out on the sale which can have a domino effect and potentially decrease market values for neighboring homes which is tremendously inefficient.
You won a free ticket to see a Bruce Springsteen concert (assume the ticket has no resale value). U2 has a concert the same night, and this represents your next-best alternative activity. Tickets to the U2 concert cost $80.00, and on any particular day, you would be willing to pay up to $100.00to see this band. Assume that there are no additional costs of seeing either show. Based on the information presented here, what is the opportunity cost of seeing Bruce Springsteen?
The opportunity cost of attending the Bruce Springsteen concert is $20. By attending the Bruce Springsteen concert, you abstain from the $100 of benefits you would have received from going to the U2 concert. You also relinquish the $80 of costs that you would have acquired by choosing to attend the U2 concert. An avoided benefit is a cost, and inversely an avoided cost is a benefit. The opportunity cost of seeing Bruce Springsteen, the value you relinquish by not attending the U2 concert is $20.
Due to the housing bubble, many houses are now selling for much less than their selling price just two to three years ago. There is evidence that homeowners with virtually identical houses tend to ask for more if they paid more for the house. What fallacy are they making?
The fallacy that is being made is that the property sellers feel that the selling price should be equal to the original purchase price. The hidden-cost fallacy occurs when you ignore relevant costs which are variable. The sellers are not associating the selling price to the current demand and supply of the housing market but rather to what the seller originally paid for the property. The sellers are not assessing the current value of the market but rather assuming that the values of their houses have remained the same even though they have drastically dropped due to the high rate of foreclosures and defaults. The sellers are denying the decrease in property prices therefore making the fallacy of relating the selling price to the buying price of the property.
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