Chapter 35 85
86 Chapter Highlights
Externalities
A. Consumption externality occurs when an agent cares directly about another
agent’s consumption or production of some good
B. Production externality occurs when a firm’s production function depends on
choices of another firm or consumer
C. Example: smokers and nonsmokers
1. two roommates who consume smoke and money; one likes smoke, the other
doesn’t
2. depict preferences
3. depict endowment
a) each has $100
b) but what is initial endowment of smoke?
4. under some conditions, the amount of smoke is independent of the assign-
ment of property rights. Figure 31.2.
D. Production externalities
1. S, a steel firm and F, a fishery
2. steel: maxspss−cs(s, x)
E. Efficient solution
1. merge and maximize joint profits
2. internalize the externality
3.
max
5. joint firm takes interaction into account
Chapter 35 87
6. private costs and social costs
7. how to get firms to recognize social cost
8. market solution to externalities
a) either firm has incentive to buy out the other and internalize the
externality
86 Chapter Highlights
Externalities
A. Consumption externality occurs when an agent cares directly about another
agent’s consumption or production of some good
B. Production externality occurs when a firm’s production function depends on
choices of another firm or consumer
C. Example: smokers and nonsmokers
1. two roommates who consume smoke and money; one likes smoke, the other
doesn’t
2. depict preferences
3. depict endowment
a) each has $100
b) but what is initial endowment of smoke?
4. under some conditions, the amount of smoke is independent of the assign-
ment of property rights. Figure 31.2.
D. Production externalities
1. S, a steel firm and F, a fishery
2. steel: maxspss−cs(s, x)
E. Efficient solution
1. merge and maximize joint profits
2. internalize the externality
3.
max
5. joint firm takes interaction into account
Chapter 35 87
6. private costs and social costs
7. how to get firms to recognize social cost
8. market solution to externalities
a) either firm has incentive to buy out the other and internalize the
externality