How to handle externalities caused by your roommate

This activity is perfect for a Principles of micro course.
Students should have covered the definition of an externality (both positive and negative).Students will have been introduced to externalities and have a general understanding that externalities cause sub-optimal market activity to occur. They will have covered socially optimal outcomes and they will have seen a payoff table like the one in the prompt.

There are no limitations on class size.
The activity takes 5-8 minutes depending on the time allotted to the group discussion and the debrief.

Overview

This activity is designed to get students thinking about how to solve situations where one roommate is creating negative externalities that affect the other roommate. After completing the exercise students will understand how to identify mutually beneficial gains from trade, achieve socially optimal results, and minimize negative externalities.

Importantly, since negotiation between two parties is very low cost, they may be able to reach a satisfactory resolution without involving a third party (apartment manager, law enforcement).

This example has applications to the environment, climate change, property rights, and common property.

Expected Student Learning Outcomes

Students will examine a cost/benefit table to attempt to find unrealized gains. At the end of this activity the students will:

Be able to identify the socially optimal result.
Understand that two parties can often solve externality problems when negotiation is very low cost.

Information Given to Students

No Loud Music Loud Music
Roommate $50/month $70/month
You $50/month $10/month

Which of these are possible solutions? (choose all that are correct.)
You pay your roommate $10 to stop playing music.
Your roommate pays you $25 to leave the room.
You pay your roommate $35 to stop playing music.
Your roommate pays you $25 but you can stay in the room.

Prefatory remarks:
I have an activity that I hope you will enjoy! Does your roommate ever do things that bother you? Do you bother your roommate sometimes? In this activity, you will have a chance to resolve a challenging situation through negotiation.
Answer for the question:

NOTE: C is best, this amount is between what you are willing to pay ($40) and the amount they are willing to accept ($20). The other three numerical answers are partially defensible, but ultimately have at least one logical error. E is possible as well but does not offer a Coasian solution.

Summary remarks:

Externalities cause market failure and they are not socially optimal. One way to remedy this is through negotiation between private parties. If the parties reach an agreement to eliminate the externality amongst themselves this is known as a Coasian solution. Sometimes, private parties are unable to achieve a satisfactory resolution, when this is the case the government can regulate, tax or subsidize to achieve an outcome that is better for society.

What amount could you pay your neighbor to stop playing loud music during the afternoon, so that you both benefit? The dollar amount in the table refers to how much each individual values each outcome.

Playing loud music Having quiet afternoons
Neighbor $120 $100
You $80 $110

(1) What is the socially optimal outcome?
a. Your roommate plays loud music and everything in the apartment complex that you live in comes to your room to enjoy the party.
b. Your roommate plays loud music and you two jam out.
c. Your roommate does not play loud music.
d. You buy your roommate expensive noise-canceling headphones that cost $200 and eliminate the externality entirely.

(2) What amount could you pay your neighbor to stop playing loud music during the afternoon, so that you both benefit? The dollar amount in the table refers to how much each individual values each outcome.
a. $10
b. $15
c. $25
d. $35