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2010 slides_externalities - 1 Externalities There is no cod...

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1 Externalities ° There is no cod in Newfoundland. Is there over°sh- ing in farm °sh? cat °sh? farm salmon? ° Which is healthier? Farm raised beef and turkey or wild deer and turkey? ° What is global warming? How is Canada satisfy- ing the Kyoto accord? We are buying ±greenhouse credits" from countries that are not using all their credits. Is this good or bad? ° Are Facebook and other social network sites new eco- nomics?
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1.1 Externalities ° Often, when an agent produces good X, it also pro- duces good Y which the agent may not value fully. 1. A °rm produces output and also pollution. Note that pollution hurts the °rm and also other agents. 2. Jill builds a beautiful house and the neighbors also enjoy looking at it. 3. When you catch a young °sh, you bene°t but the °sh cannot grow to be a big °sh for somebody else to catch. 4. Peer e/ects & grading on a curve. Are students working too hard?
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° Negative externality: Others dont like the good Y. ° Positive externality: Others like the good Y. ° There is no market for this other good. The good is not priced. So the agent producing good Y does not take into account its e/ect on others in society. 1. The °rm assumes that it can pollute without cost. 2. The view of the house to the neighbors is free. 3. You may be willing to throw the small °sh back if you could be compensated. 4. Professors do not take into account the over ex- ertion of e/ort. ° Positive externalities include liquidity e/ects (Ebay), network externalities (Linux), English as a common language (Is this a positive externality?).
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1.2 The tragedy of the commons. ° There are n identical non-cooperative °shers. ° Fishers can catch °sh today or throw it back to be caught tomorrow. (We ignore longer horizon) ° We are looking at the Nash Equilibrium of this game. So we need to compute the payo/ if he catches it today and the payo/ if he throws it back. Then given what everyone else does, we have to °nd his best response. Finally, we want to make sure that at the Nash Equilibrium, everyone is playing their best response. ° A °sher catches a °sh of size s . One kg of °sh can sell for p . So he can sell the °sh today for ps .
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° If he throws it back into the sea, the new size to- morrow is g ( s ) ° His probability of catching it tomorrow is 1 n . ° So his expected revenue tomorrow is pg ( s ) n . ° His discounted revenue from throwing it back is pg ( s ) n (1+ r ) where r is the discount rate.
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° He will throw it back if pg ( s ) n (1 + r ) > ps g ( s ) n (1 + r ) > s ° Assume that g ( s ) is increasing at a decreasing rate in s .
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