Managerial Economics Jack Wu

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

Externalities(c) , Ivan Png 3 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

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

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

Externalities(c) , Ivan Png 7 London: The City New York: Wall Street Hong Kong: Central Singapore: Raffles Place Financial Centers

Resolving Externalities Economic inefficiency  opportunity for profit merger collective action

Externalities(c) , Ivan Png 9 Intel Inside Cooperative advertising resolves positive externality from one retailer to other retailers

Network Externality 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

Critical Mass definition: number of users at which demand becomes positive

Network Effects: Demand Elasticity highly elastic around tipping point highly inelastic at low demand levels

Public Good Non-rival consumption -- one person ’ s increase does not reduce quantity to others  extreme economy of scale

Externalities(c) , Ivan Png15 Television Distinguish content delivery

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

Excludability Provider can exclude particular consumer law technology

Excludability: Law patent – product or process copyright – artistic expression

Externalities(c) , Ivan Png20 Intellectual Property trade-off benefit from usage incentive for future creation

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.