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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
rna
lities
3
(c) 19
99
-20
01
, Ivan
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!
Exte
rna
lities
6
(c) 19
99
-20
01
, Ivan
Pn
g
Exte
rna
lities
(c) 19
99
-20
01
, Ivan
Pn
g
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
Exte
rna
lities
9
(c) 19
99
-20
01
, Ivan
Pn
g
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
Exte
rna
lities
15
(c) 19
99
-20
01
, Ivan
Pn
g
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
Exte
rna
lities
20
(c) 19
99
-20
01
, Ivan
Pn
g
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.