E XTERNALITY Managerial Economics Jack Wu

E XTERNALITIES one party directly conveys benefit or cost to others  positive  negative benchmark: collective marginal benefit = collective marginal cost

S AKS : F IFTH A VENUE VS M ALL New York, NY: 611 Fifth Avenue Stamford, CT: Town Center Mall Chevy Chase, MD: 5555 Wisconsin Ave McClean, VA: Tysons Galleria Externalities 3 (c) , Ivan Png

group marginal benefit Sak’s marginal benefit florist’s marginal benefit profit gain from additional investment marginal cost shoe store’s marginal benefit Hundred thousand dollars of investment Marginal benefit/cost (Hundred thousand dollars ) SAK ’ S POSITIVE EXTERNALITIES

a b c marginal benefit group marginal cost Sol’s marginal cost Sak’s marginal cost Hundred thousand dollars of investment Marginal benefit/cost (Hundred thousand dollars) SAK ’ S NEGATIVE EXTERNALITIES profit gain from reducing investment

S ILICON V ALLEY Stanford University Xerox Palo Alto Research Center Hewlett-Packard Cisco Systems 3Com Yahoo! Externalities 6 (c) , Ivan Png

Externalities (c) , Ivan Png 7 F INANCIAL C ENTERS London: The City New York: Wall Street Hong Kong: Central Singapore: Raffles Place

R ESOLVING E XTERNALITIES Economic inefficiency  opportunity for profit merger collective action

I NTEL I NSIDE Cooperative advertising resolves positive externality from one retailer to other retailers Externalities 9 (c) , Ivan Png

N ETWORK E XTERNALITY Externality where benefit/cost depends on total number in network English language Internet international telephone service

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

C RITICAL M ASS definition: number of users at which demand becomes positive

N ETWORK E FFECTS : D EMAND E LASTICITY highly elastic around tipping point highly inelastic at low demand levels

P UBLIC G OOD Non-rival consumption -- one person ’ s increase does not reduce quantity to others  extreme economy of scale

T ELEVISION Distinguish content delivery Externalities 15 (c) , Ivan Png

private good public good congestible rival consumptionnon-rival consumption RIVALNESS

vertical sum of marginal benefits marginal cost Minutes of fireworks Marginal benefit/cost ($ per minute) Alan Mary Peter EFFICIENCY IN PUBLIC GOOD

E XCLUDABILITY Provider can exclude particular consumer law technology

E XCLUDABILITY : L AW patent – product or process copyright – artistic expression

I NTELLECTUAL P ROPERTY trade-off benefit from usage incentive for future creation Externalities 20 (c) , Ivan Png

D ISCUSSION 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.