kf011 - ExternalitiesandPropertyRights Ka-fu Wong Uni ver...

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1 Ka-fu Wong University of Hong Kong Externalities and Property Rights
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2 Externalities Sometimes costs or benefits that result from an activity  accrue to people not directly involved in the activity.  These are called  external costs  or  external benefits  --  externalities  for short.
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3 Example 11.1 . Sara is an accomplished  classical violinist.  Her neighbor Tom is a fan of  classical violin music, and on  summer evenings enjoys  listening to Sara play in her  garden. For Tom, Sara's music is a  positive externality. If Sara plays only in response  to her own costs and benefits,  will the amount of time she  plays be socially optimal? Itzhak Perlman Tango http://www.youtube.com/watch?v=dsU9zmnZ37g  
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4 Example 11.1 . If Sara plays in response to her own costs and  benefits, she will continue to play until the marginal  benefit of playing another minute is equal to the  marginal cost.   But since Tom also benefits from her playing, at that  point the total marginal benefit of playing another  minute will be greater than the marginal cost.
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5 Example 11.1 . Thus, if Sara plays in response to her own costs and  benefits, Sara plays too little. Marginal Cost to Sarah Marginal Benefit to Sarah Minutes T* ($/minute) 0.50 0.65 MB to Tom
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6 Example 11.2 . Sara is an accomplished  classical violinist.   Her neighbor Harry hates the  sound of violin music, and on  summer evenings becomes  distressed when Sara plays in  her garden. For Harry, Sara's music is a  negative externality.  If Sara plays only in response  to her own costs and benefits,  will the amount of time she  plays be socially optimal?
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7 Example 11.1 . If Sara plays in response to her own costs and  benefits, she will continue to play until the marginal  benefit of playing another minute is equal to the  marginal cost.   But since Harry also incurs costs from her playing, at  that point the marginal benefit of playing another  minute will be greater than their combined marginal  costs.
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8 Example 11.2 . Thus, if Sara plays in response to her own costs and  benefits, Sara plays too much. Marginal Cost to Sarah Marginal Benefit to Sarah Minutes T* ($/minute) 0.50 0.75 MC to Harry
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9 Externalities and activity Negative externalities => too much activity Positive externalities  => too little activity
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10 Example 11.3 . Smith can produce with or without a filter on his  smokestack.   Production without a filter results in greater smoke  damage to Jones. 
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11 Example 11.3 . Smith produces 
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kf011 - ExternalitiesandPropertyRights Ka-fu Wong Uni ver...

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