Externalities, Uncertainty and Irreversibility with an Application to Land Use

A recent theoretical model devoted to the positive externalities of industrial clustering in the presence of irreversibility and uncertainty is adapted to include negative externalities that may arise from environmental or other causes. Such externalities may alter the decision criteria to invest by shifting some or all of: 1) the measurement of price, 2) the measurement of productivity, or 3) the variance and other determinants of the positive wedge between price and cost. A brief review of the literature on property value externalities identifies numerous competing externalities that may affect the productivity of a given use of land. Finally, preliminary empirical estimation of new residential construction on the urban fringe of Pittsburgh reveals that it is unlikely that homebuilders are making decisions using a real options framework. The preliminary results raise the question whether the more cautious criteria with irreversibility and uncertainty applies at any stage of private sector decision making for development, and whether, from a social perspective, it should apply at some stage.