From Ch. 10, #1, #9; from Ch. 11, #2, #5. Short thought piece: Pick an "externality" that you think has important implications for social welfare. Offer some evidence of its empirical significance. What kinds of public policies would you recommend to deal with it?

Some hints for homework: Ch. 10, no. 1

First, figure out the payoffs:

A good grade will give him the benefit of 20; an average grade a benefit of 5; a poor grade a benefit of 0.
By studying a lot, he incurs a cost of 10; by studying little a cost of 6.
If he studies a lot and gets a good grade the net payoff is 10.
If he studies a lot and gets an average grade the net payoff is -5.
If he studies little and gets an average grade the net payoff is -1.
If he studies little and gets a poor grade the net payoff is -6.

Next, figure out how students' behavior will affect each other's grade.

The assumption here is that exams are being graded on a curve.
If everyone studies the same amount, they will all get average grades.
If Sam studies hard and no one else does, he will get a good grade and they will get poor ones.
If Sam doesn't not study hard and everyone else does, he will get a poor grade and they will get good ones.

Chapter 11

Externalities and Property Rights

Priorities:

-applications of payoff matrices
--define externalities
-graphically illustrate their implications for the relationship between individual and social efficiency
-the Coase theorem
-the "optimal amount of pollution"
-the "Tragedy of the Commons"

the "positional externality." This arises from a competitive situation in which individual players have an incentive to incur something harmful to themselves or others in order to win. But if they both do it, incurring the harm gives neither a strategic advantage. As in the Prisoner's Dilemma, they are worse off pursuing their individual self interest than they would be if figured out a way to coordinate their actions and follow an enforceable rule.

Externalities are a cost that falls on people other than those who pursue the activity, or make the individual choice in question.

A memorable example of a negative externality is a fart (when other people are nearby).

Most forms of pollution are negative externalities

A beekeeper in a crowded area in which bees are likely to sting people is creating a negative externality.

A memorable example of a positive externality is a good joke, especially if it is overheard by or gets passed onto a lot of people who weren't a part of the original audience which may have paid for it.

I would like to think that a smile also creates a positive externality.

Trust, kindness, and reciprocity create positive externalities, as do rules that prevent individuals from getting stuck in coordination problems such as those represented by prisoner dilemma type situations.

A beekeeper living next to an apple orchard is creating a positive externality--the pollination of the trees.

Negative externalities create a divergence between private and social cost. They imply that social cost is higher than private cost. This can be graphically represented by a social cost curve that is above and to the left of the private cost curve. The intersection of this social cost curve with demand will be to the left of the intersection of private cost and demand. That is, the socially efficient point will be to the left of the point that utility maximizing individuals would choose.

In this situation, private choices lead to too much of something....like, too many cars (relative to bikes), and as a result too much air pollution.

Positive externalities create a divergence between private and social benefit. They imply that social benefits are greater than private benefits. This can be graphically represented by a demand curve that is above and to the right of the private demand curve. The intersection of social demand and private cost will be to the right of the intersection of private demand and private cost. That is, the socially efficient point will be to the right of the point that utility maximizing individuals would choose. In this situation private choices will lead to an insufficient amount of something...like, not enough bikes (relative to cars) and as a result, not enough good health, gnarly calves and smiling faces.

See Figure 11.1, which is reproduced in slide 11-4. This is the most important figure of the chapter.

The 60 Minutes clip McLibel offers an interesting example of a lawsuit that was brought against a British environmental group for passing out leaflets criticizing McDonald's practices.

What were the negative externalities the leafletters were complaining about?

Among other things, they claimed that McDonalds was promoting poor nutrition, destruction of rain forest habitat, and child labor.

What were the negative externalities that McDonalds was complaining about?

Libel, or unfair attack on the reputation of the company.

Who won the lawsuit?

I went to check out the website mcspotlight.org which offers more info about the McDonald's libel case. I accidentally typed mcspotlight.com, which is a porn site. This, to me, is an example of a negative externality.