External costs and benefits

• External cost = negative externality: cost of an activity that falls on people other than those who pursue the activity.

• External benefit = positive externality: benefit of an activity received by people other than those who pursue the activity.

• Externality: external cost or benefit of an activity.

• Coase theorem: if at no cost people can negotiate the purchase and sale of the right to perform activities that cause externalities, they can always arrive at efficient solutions to the problems caused by externalities.

Property rights and the tragedy of the commons

• Tragedy of the commons: tendency for a resource that has no price to be used until its marginal benefit falls to zero.

  • In many cases, an efficient remedy is to define and enforce rights to the use of valuable property. But this solution is difficult to implement for resources such as the oceans and the atmosphere because no single government has the authority to enforce property rights for these resources.

Positional externalities

• Positional externality occurs when an increase in one person's performance reduces the expected reward of another's in situations in which reward depends on relative performance.

• Positional arms race: series of mutually offsetting investments in performance enhancement that is stimulated by a positional externality.

• Positional arms control agreement: agreement in which contestants attempt to limit mutually offsetting investments in performance enhancement.