Managerial 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
Externalities
(c) 1999-2001, Ivan Png
Marginal benefit/cost
(Hundred thousand dollars)
15
13.4
Sak’s Positive
Externalities
group marginal benefit
10
Sak’s marginal benefit
9
florist’s marginal
benefit
4
3.6
profit gain from
additional investment
1
0.8
marginal
cost
0
1
shoe store’s
marginal benefit
5
9
10
Hundred thousand dollars of investment
Sak’s Negative
Externalities
10
marginal benefit
profit gain from
reducing investment
group marginal cost
b
a
2
Sol’s marginal cost
1
0
c
5
7.5
9
Sak’s marginal cost
10
Hundred thousand dollars of investment
Silicon Valley
 Stanford University
 Xerox Palo Alto Research Center
 Hewlett-Packard
 Cisco Systems
 3Com
 Yahoo!
Externalities
(c) 1999-2001, Ivan Png
Financial Centers
•
•
•
•
London: The City
New York: Wall Street
Hong Kong: Central
Singapore: Raffles Place
Externalities
(c) 1999-2001, Ivan Png
Resolving Externalities
Economic inefficiency  opportunity for profit
 merger
 collective action
Intel Inside
Cooperative advertising resolves positive externality
from one retailer to other retailers
Externalities
(c) 1999-2001, Ivan Png
Network Externality
Externality where benefit/cost depends on total number
in network
 English language
 Internet email
 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
Television
Distinguish
 content
 delivery
Externalities
(c) 1999-2001, Ivan Png
Rivalness
congestible
private good
rival consumption
public good
non-rival consumption
Efficiency in Public Good
Marginal benefit/cost ($ per minute)
10
8.9
vertical sum of marginal benefits
5.6
marginal cost
5
4.5
4
3.6
Alan
Mary
1
0.8
0
Peter
1
4
5
Minutes of fireworks
10
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
Externalities
(c) 1999-2001, Ivan Png
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.