Question

Betty and Anna work at the same office in Philadelphia and they have to attend a meeting in Pittsburgh. They decide to drive to the out-of-town meeting together. Betty is a cigarette smoker and her marginal benefit from smoking a pack of cigarettes a day is \(\$ 40 .\) Cigarettes are \(\$ 6\) a pack. Anna dislikes cigarette smoke, and her marginal benefit from a smoke-free environment is \(\$ 50\) a day. What is the outcome if a. Betty drives her car with Anna as a passenger? b. Anna drives her car with Betry as a passenger?

Short answer

a. Betty only drives without smoking if Anna compensates her up to $34. b. Anna enforces a no-smoking policy if she drives.

Step-by-step solution

Understanding Marginal Benefits

First, understand the marginal benefits for both individuals. Betty’s marginal benefit from smoking a pack of cigarettes a day is \(\$40\), and Anna’s marginal benefit from a smoke-free environment is \(\$50\) a day.

Calculating Costs and Benefits for Betty

If Betty smokes a pack of cigarettes a day, her cost would be \(\$6\), and her net benefit would be \(\$40 - \$6 = \$34\).

Outcome if Betty Drives

If Betty drives and chooses to smoke, Anna’s disutility would be \(\$50\). Since Anna’s disutility from smoke is greater than Betty’s net benefit from smoking, Anna might negotiate to pay Betty up to \(\$34\) to abstain from smoking. If a deal is struck, Betty will not smoke.

Outcome if Anna Drives

If Anna drives, she can enforce a no-smoking policy. Betty might offer to pay Anna to be allowed to smoke, but Anna would reject any offer less than \(\$50\) (since her marginal benefit is \(\$50\)). Therefore, Betty will not be allowed to smoke.

Key concepts

cost-benefit analysis

Cost-benefit analysis is essential when making decisions that involve different preferences and costs for individuals. It helps us understand the net benefits for each person involved. In this exercise, Betty's marginal benefit from smoking is \(\text{\textdollar}40\), while her cost is \(\text{\textdollar}6\) per pack. This results in a net benefit of \(\text{\textdollar}34\). On the other hand, Anna has a marginal benefit of \(\text{\textdollar}50\) from a smoke-free environment.

Cost-benefit analysis allows us to compare these net benefits directly. We can see that Anna's benefit from not being exposed to smoke (\text{\textdollar}50) is higher than Betty's net benefit from smoking (\text{\textdollar}34). Therefore, it would make sense for Anna to propose compensating Betty for abstaining from smoking, ensuring both parties reach a mutually beneficial outcome.

Key points to remember about cost-benefit analysis:

• Determine the marginal benefits and costs for all individuals involved.
• Calculate the net benefits by subtracting costs from benefits.
• Compare the net benefits to make informed decisions.

negotiation

Negotiation plays a crucial role when individuals with different preferences must coexist or make collective decisions. In the given scenario, Betty's desire to smoke conflicts with Anna's preference for a smoke-free environment.

Since Anna's marginal benefit of \(\text{\textdollar}50\) for a smoke-free space is greater than Betty's net benefit of \(\text{\textdollar}34\) for smoking, it sets the stage for a potential negotiation. Anna might offer Betty a payment of up to \(\text{\textdollar}34\) to stop smoking during the trip, as that is the amount needed to match Betty's benefit from smoking.

Important aspects of negotiation:

• Understand the preferences and benefits of each party.
• Determine if the outcome can be improved through compensation or trade-offs.
• Aim for a mutually beneficial solution where each party gains more by compromising than sticking to their initial position.

externalities

Externalities refer to the impact of one person's actions on the well-being of another. They can be positive or negative, depending on whether the action confers a benefit or imposes a cost on others. In our scenario, Betty smoking has a negative externality on Anna as it reduces her enjoyment by \(\text{\textdollar}50\).

This negative externality means that the cost of smoking is not just borne by Betty, but also by Anna, who experiences discomfort from the smoke. Anna's preference for a smoke-free environment signifies the external cost of Betty's smoking to her. Understanding externalities helps highlight the broader impacts of personal actions and is vital for making fair decisions.

Key points about externalities:

• Externalities occur when a person's action affects others not directly involved in the decision.
• Negative externalities impose additional costs, while positive externalities confer benefits.
• Addressing externalities typically involves negotiating compensations or regulations to mitigate undesired effects.