kf012 - 1 Ka-fu Wong University of Hong Kong Externalities...

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Unformatted text preview: 1 Ka-fu Wong University of Hong Kong Externalities and Property Rights 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. 3 Example 12.1 . 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? 4 Example 12.1 . 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. 5 Example 12.1 . 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* ($/minute) 0.50 0.65 MB to Tom 6 Example 12.2 . Sara is an accomplished classical violinist. Her neighbor Harry hates the sound of violin music, and on summer evenings becomes distressed when Sara plays in her garden. For Harry, Sara's music is a negative externality. If Sara plays only in response to her own costs and benefits, will the amount of time she plays be socially optimal? 7 Example 12.1 . If Sara plays in response to her own costs and benefits, she will continue to play until the marginal benefit of playing another minute is equal to the marginal cost. But since Harry also incurs costs from her playing, at that point the marginal benefit of playing another minute will be greater than their combined marginal costs. 8 Example 12.2 . Thus, if Sara plays in response to her own costs and benefits, Sara plays too much. Marginal Cost to Sarah Marginal Benefit to Sarah Minutes T* ($/minute) 0.50 0.75 MC to Harry 9 Externalities and activity Negative externalities => too much activity Positive externalities => too little activity 10 Example 12.3 . Smith can produce with or without a filter on his smokestack. Production without a filter results in greater smoke damage to Jones. 11 Example 12.3 ....
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kf012 - 1 Ka-fu Wong University of Hong Kong Externalities...

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