Question

Review the section of the chapter titled, "The Private Solution" for negative externalities. Suppose that the truck driver gains \(\$ 12\) by using the shortcut, and the harm to the resident is \(\$ 7 .\) a. Is it efficient for the truck driver to stay on the highway and not use the shortcut? Briefly, why or why not? b. If the truck driver has the legal right to use the shortcut, would you expect the resident to offer him a sufficient side payment to get him to stay on the highway? Why or why not? c. If the resident has the legal right to block the truck driver from using the shortcut, would you expect the truck driver to stay on the highway? Why or why not?

Short answer

a. Yes, it is efficient for the truck driver to use the shortcut because the net gain (\(\$5\)) is positive. b. No, the resident is unlikely to offer a payment larger than \(\$12\). c. Yes, because the truck driver no longer considers the \(\$12\) benefit.

Step-by-step solution

Problem Interpretation

First, understand the context of the question. An externality exists when a decision incurs costs or benefits to a third-party not responsible for making the decision. The question talks about a truck driver and a resident affected by the truck using a shortcut.

Analyzing Efficiency

a. To determine the efficiency, add up the cost and benefits of the decision. Truck driver gains \(\$12\) by using the shortcut, whereas the resident incurs a harm of \(\$7\). The net benefit here is \(\$12 - \$7 = \$5\). Therefore, it is economically efficient for the truck driver to use the shortcut, despite the harm to the resident, because the aggregate surplus is positive.

Reasoning Legal Rights

b. If the truck driver has the legal right to use the shortcut, there is no incentive for him to accept any payments from the resident unless the payment offered by the resident is more than \(\$12\), which is the benefit the truck driver gets from the shortcut. Therefore, unless the resident offers more than \(\$12\), the truck driver would continue to use the shortcut.

Residential Rights Impact

c. If the resident has the legal right to block the truck driver from using the shortcut, the truck driver would no longer consider the \(\$12\) benefit. Therefore, one would expect the truck driver to stick to the highway unless the resident compensates him for incidences where the shortcut is blocked. The truck driver will stay on the highway because it would not be worth his time or cost to negotiate with the resident about using the shortcut.

Key concepts

Economic Efficiency

Understanding economic efficiency can be as straightforward as summing up gains and losses. It is the golden rule of making the most out of what we have. In the realm of microeconomics, economic efficiency occurs when the cost of a choice is less than or equal to the benefits derived from it.

Consider a truck driver taking a shortcut that saves money. If his gain is \(\$12\) and the resident’s loss is \(\$7\), the overall benefit is \(\$5\). It may seem counterintuitive, but it’s efficient because, in total, society is \(\$5\) better off, even though the gains and losses are distributed unequally. This showcases that economic efficiency is not always about fairness or equity but the net positive impact on welfare.

Legal Rights and Economic Outcomes

Now, let's delve deeper into how legal rights influence what happens economically. The assignment of legal rights can have a significant effect on economic behavior and outcomes. When a truck driver has the right to use a shortcut, he has less motivation to negotiate because he already possesses what he wants. In this case, the resident would have to make the transaction worth it for the truck driver to divert his route.

If the legal right shifts to the resident, the driver’s decision-making is altered. Now, the resident holds the power to either permit or block the driver's preferred route. This situation illustrates the 'Coase Theorem', which suggests that as long as transaction costs are negligible and property rights are clearly defined, parties can negotiate to reach an agreement that results in the efficient use of resources, regardless of who holds the rights initially.

Negative Externalities

Negative externalities are a crucial concept in economics that describe the spillover costs incurred by someone who did not choose to be involved in an economic activity. Taking our example, the resident bears a negative externality in the form of harm (\(\$7\)) due to the truck driver's actions.

The impact of such externalities is often underappreciated – they can distort market outcomes and lead to a loss of economic efficiency in the broader sense. Addressing them usually requires interventions, such as taxes to discourage the action causing harm or negotiating solutions that 'internalize' the externality, compelling those responsible for the negative impact to account for the broader costs of their decisions, aligning individual incentives with overall social welfare.