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bert_and_ernie - Can the Market Solve an Externality...

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Can the Market Solve an  Externality Problem? Bert and Ernie live together on Sesame Street. Ernie would like to count sheep in order to go to sleep. But that keeps Bert up. They have “payoffs” that look like this: What is the best number of sheep counted? How many will Ernie count? If Bert can pay off Ernie, what deal will they make? What if Ernie has to pay off Bert, what deal will they make? Note if Ernie is “left alone” he will count 5 sheep – not the wealth maximizing number. Sheep Counted Ernie’s Happiness (marginal) Bert’s Happiness Total Wealth 1 10 (10) -1 (-1) 9 (9) 2 18 (8) -3 (-2) 15 (6) 3 24(6) -7 (-4) 17 (2) 4 30 (6) -15 (-8) 15 (-2) 5 31 (1) -25 (-10) 6 (-9)
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 Let’s Negotiate Now assume that Ernie owns the right to count sheep – but Bert can pay him not to count. How much is Bert willing to pay Ernie not to count the 5 th sheep? 10 How much value does Ernie get from counting the 5 th sheep? 1. So a deal not to count the 5 th sheep is available at some price [1,10].
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