Response based on discussion post "Development of Shopping Area -When I was growing up, the downtown area of my town underwent a significant renovation, which led to the development of a large shopping area with popular stores and restaurants. While it was nice to live close to this, it also led to a negative externality of increased traffic near our house. This increased the amount of time that it took us to drive through the downtown area after school or soccer practice, which took away time from other productive activities that my parents and I could have undertaken, such as working on homework or cooking dinner. There was likely also a cost to my parents in the form of extra spending on gas caused by sitting in traffic for longer periods of time. The externality was a pecuniary one, as the market value of the homes in the area rose with the additional attractions nearby. Therefore, the people impacted by the shopping development were fairly compensated for the negative externality they experienced with traffic."

Address the following questions (you need to answer (a) and either (b) or (c)) based on above. Do not hesitate to be critical of the example.

a. Does the example meet the conditions for a well-defined externality? Why or why not? Go over the conditions and explain.

b. If the answer to (a) is yes, is the externality pecuniary (i.e., does a price change?), or real (i.e., there is no market for it)? Explain. If the externality is real, suggest a way to correct it that is not the one suggested by the author of the thread. Be explicit about how your suggestion will correct the problem.

c. If the answer to (a) is no, suggest a modification or variation of the example that would meet the conditions for a well-defined externality. Identify the activity, decision, or transaction that creates the externality in your modified example. Is your modified example a pecuniary or a real externality? Explain why. If the externality is real, suggest a solution to solve it and explain how it would work.

Externality Roadmap 1. Is there an economic activity or transaction? a. If no, there is no externality b. If yes, go to 2 2. Does the activity or transaction create benefits or costs for third parties? a. If no, there is no externality b. If yes, go to 3 3. Are the benefits or costs created for third parties reflected in a market price? a. If yes, this is a pecuniary externality and does not need to be corrected b.\\ If no, this is a real or technological externality and taking steps to correct it will improve efficiency (now go to 4) 4. Is the real externality positive or negative? a. If it creates a benefit, it is positive, and correcting it involves providing incentives to increase 20 the level of activity b. If it creates a cost, it is negative, and correcting it involves providing incentives to limit or decrease the level of activity