1. “To Catch a Thief” “a polelike device that locks the steering wheel” sells for $29.95 “a radio transmitter” that “summons the police” if the car is stolen. Sells for $695 and is installed (mostly) on new cars. Police require that no LoJack decals be on cars. 95% of stolen cars with LoJack are recovered versus 60% of stolen cars without LoJack.

2. Externalities Externality—the behavior of one agent (person or firm) affects another agent in a way that is external to markets. negative externalities, e.g., “The Club” (  prob others will be stolen),chewing tobacco (disease and soiling),alcohol (drunk driving),road salt (car damage),and antibiotics (disease resistant bacteria). positive externalities, e.g., LoJack (  prob others will be stolen),meningitis vaccine (disease), and education (better citizens). Observable by Criminals Unobservable by Criminals

3. Founded in 1879 19th & Early 20th Century Chewing Tobacco The founders of Mail Pouch came up with the idea when they noticed that people liked chewing the clippings of stogie wrappers. Mail Pouch paid barn owners $1 to $2 a year and painted the rest of the barn as well.

4. 19th and Early 20 th Century Chewing Tobacco Quotes from Richard Kluger’s, Ashes to Ashes Chewing Tobacco: Messy: spit aimed at “ubiquitous cuspidor(s)” hit “carpets, walls, draperies, and trousers. ” Dangerous: “spreader of tuberculosis and other contagions.” “splendidly suited” to 19 th Century outdoor life In early 20 th Century:

5. Early 20 th Century Courthouse Cuspidor

6. S P MKT Q MKT D Q CT P CT (private cost) Social Cost Q*Q* Efficient Q external cost—the health and cleanup costs imposed on others from tobacco spit. Market for Chewing Tobacco (CT), 1900

7. The Market for Chewing Tobacco P CT Q MKT > Q * Q CT S MKT Social Cost D external cost Market Failure: Negative externalities cause markets to For each pouch of chewing tobacco produced, the social cost includes the private costs of producing the chewing tobacco plus the cost to those bystanders adversely affected by the spit from that pouch. Q’Q’ producing Q’ Social cost of Private cost of producing Q’ Q * Q MKT produce a larger quantity than is efficient.

8. S P MKT Q MKT D Q CT (private cost) Social Cost Q* DWL in the Market for CT, 1900 Q’ B A P CT Q MKT Q * to are the excess pouches of CT that society would rather not produce from an efficiency perspective. Willingness to Pay for Q’ (benefits) Social Cost of Q’ = ____ = _______ B BA + Costs > Benefits by A DWL due to Q’ DWL of Q*- Q MKT

9. The onset of mouth ulcers and cancers caused by chewing tobacco is higher than typical smoking related diseases that affect your lungs, so guys who like chewing tobacco don’t like to chew ANYTHING ELSE—maybe even for the rest of their lives. Who loves a good chew?

10. The Market for Chewing Tobacco Is this damage part of the negative externality? If not, where is it represented in the model? P MKT P CT Q MKT Q*Q* Q CT S MKT Social Cost D external cost No * The expected health damage from chewing tobacco helps determine the demand for chewing tobacco. The damage may still be the result of a market failure (lack of info) but not via an externality. Caveat*: This damage could create a negative externality via the system of financing health care

11. P MKT P CT Q MKT Q*Q* Q CT Social Cost Correcting the Market Failure Changing incentives so people (or firms) take account of the external effects of their behaviors is called internalizing the externality. S MKT D P MKT P CT Q NT QTQT Q CT S D The government can internalize the externality by imposing a tax on chewing tobacco (assume that tobacco companies pay it). S Tax(T) external cost tax Q T will equal Q* if the tax (per pouch) = the negative externality (per pouch). MKT PTPT

12. S D Q LJ P LJ (private cost) Market for LoJack (LJ) Social value P MKT External benefit (the value of  in prob. that other cars will be stolen) Q MKT Q* (private value) Positive externalities cause markets to produce a smaller Q than is efficient. DWL

13. Correcting the Market Failure S D Q LJ P LJ 0 Social P MKT External benefit value S D Q LJ Subsidy S s P LJ P MKT PSPS 0 Q MKT Q* Q MKT QSQS The government can internalize the externality by giving a subsidy to the producer of LoJack. Q S will equal Q* if the subsidy (per LoJack) = the positive externality (per LoJack).

14. Correcting the Market Failure Alteratively, economists Ayres and Nalebuff “urge regulators to require insurers to give discounts to LoJack users.” Suppose the government requires insurers to give discounts of $200 to people who purchase LoJack. S D Q LJ P LJ 0 Social P MKT External benefit value S D Q LJ $200 P LJ P MKT 0 Q MKT Q* Q MKT D’ Q’ P’

15. Auto Thefts (# per 100,000 people) LoJack was approved for use in Boston in 1986 Boston (port city) Non- LoJack Cities Empirical Study by Ayres and Levitt Results: (1) 50%  in Boston car thefts, were shut down in LA after LoJack arrived, (2) 53 chop shops (3)  1 theft annually per 3 LoJacks installed. 4000 3000 2000 1000