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Chapter 5: Problem 5

Briefly explain the relationship between property rights and the existence of externalities.

Short Answer

Expert verified
Property rights are the legal rights of individuals or firms to utilize economic resources, while externalities are the indirect costs or benefits incurred by third parties. When property rights are well-defined and enforced, it helps in minimizing the negative externalities and enhancing positive externalities as individuals or firms aim to maximise the value of their property.

Step by step solution

01

Understand Property Rights

Property rights are the legal rights of ownership on a particular good or resource. It allows individuals to make decisions about those resources, including what benefits to generate from these resources and which actions to undertake that might affect the value of these resources.
02

Understand Externalities

Externalities are effects of a transaction that affect third parties. These can be either positive externalities, where third parties benefit, or negative externalities, where third parties are adversely affected. These are not reflected in the cost of goods or services.
03

Link between Property Rights and Externalities

When property rights are well defined and enforced, externalities are minimized. This is because the owner has the incentive to maximize the value of their property. Therefore, they will not undertake actions that could negatively affect the value of their property and cause negative externalities. At the same time, the property rights also encourage beneficial activities that can cause positive externalities.

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