EXTERNALITYManagerial Economics

Jack Wu

EXTERNALITIES

one party directly conveys benefit or cost to others� positive� negative

benchmark: collective marginal benefit = collective marginal cost

SAKS: FIFTH AVENUE VS MALL

New York, NY: 611 Fifth Avenue Stamford, CT: Town Center Mall Chevy Chase, MD: 5555 Wisconsin Ave McClean, VA: Tysons Galleria

Exte

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3

(c) 19

99

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Pn

g

0

0.81

3.64

15

13.4

10

9

1 5 9 10

group marginal benefit

Sak’s marginal benefit

florist’s marginalbenefit

profit gain fromadditional investment

marginalcost

shoe store’smarginal benefit

Hundred thousand dollars of investment

Marg

inal benefit/

cost

(Hundre

d t

housa

nd d

olla

rs)

SAK’S POSITIVE EXTERNALITIES

0

1

2

10

5 7.5 9 10

ab

c

marginal benefit

group marginal cost

Sol’s marginal cost

Sak’s marginal cost

Hundred thousand dollars of investment

Marg

inal benefit/

cost

(H

undre

d t

housa

nd

dolla

rs)

SAK’S NEGATIVE EXTERNALITIES

profit gain fromreducing investment

SILICON VALLEY

Stanford University Xerox Palo Alto Research Center

Hewlett-Packard Cisco Systems 3Com Yahoo!

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7

FINANCIAL CENTERS

• London: The City• New York: Wall Street• Hong Kong: Central• Singapore: Raffles Place

RESOLVING EXTERNALITIES

Economic inefficiency opportunity for profit merger collective action

INTEL INSIDE

Cooperative advertising resolves positive externality from one retailer to other retailers

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NETWORK EXTERNALITY

Externality where benefit/cost depends on total number in network English language Internet email international telephone service

NETWORK EFFECTbenefit/cost depends on total number in network through market, not directly conveyed resolved by producer or service provider

CRITICAL MASS

definition: number of users at which demand becomes positive

NETWORK EFFECTS: DEMAND ELASTICITY

highly elastic around tipping pointhighly inelastic at low demand levels

PUBLIC GOOD

Non-rival consumption -- one person’s increase does not reduce quantity to others

extreme economy of scale

TELEVISION

Distinguish content delivery

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15

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private good public goodcongestible

rival consumption non-rival consumption

RIVALNESS

0

0.81

3.64

4.55

5.6

8.9

10

10541

vertical sum of marginal benefits

marginal cost

Minutes of fireworks

Marg

inal benefit/

cost

($

per

min

ute

)

Alan

Mary

Peter

EFFICIENCY IN PUBLIC GOOD

EXCLUDABILITY

Provider can exclude particular consumer law technology

EXCLUDABILITY: LAW

patent – product or process copyright – artistic expression

INTELLECTUAL PROPERTY

trade-off benefit from usage incentive for future creation

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DISCUSSION

Let b represent marginal benefit and q the amount of Sogo’s investment in the new ZhongXiao Fushing store. Suppose that the investment generates marginal benefis, b=10-q for Sogo, b=4-0.4q for the florist, and b=1-0.2q for the shoe store. Given the marginal cost of 1, calculate the profit-maximizing quantity of Sogo’s investment and the economically efficient quantity of Sogo’s investment.