Managerial EconomicsJack Wu

Externalitiesone party directly conveys benefit or cost to

others� positive� negative

benchmark: collective marginal benefit = collective marginal cost

Externalities (c) 1999-2001, 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

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

Externalities (c) 1999-2001, Ivan Png 6

Silicon Valley Stanford University Xerox Palo Alto Research Center

Hewlett-Packard Cisco Systems 3Com Yahoo!

Externalities (c) 1999-2001, Ivan Png 7

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

Financial Centers

Resolving ExternalitiesEconomic inefficiency opportunity for profit merger collective action

Externalities (c) 1999-2001, Ivan Png 9

Intel InsideCooperative advertising resolves positive externality from one retailer to other retailers

Network ExternalityExternality 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 Massdefinition: number of

users at which demand becomes positive

Network Effects: Demand Elasticity

highly elastic around tipping pointhighly inelastic at low demand levels

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

extreme economy of scale

Externalities (c) 1999-2001, Ivan Png 15

TelevisionDistinguishcontentdelivery

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

ExcludabilityProvider can exclude particular consumer law technology

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

Externalities (c) 1999-2001, Ivan Png 20

Intellectual Propertytrade-offbenefit from usageincentive for future creation

DiscussionLet 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.