The Impact of Refunds on Neighborhood Beautification

7. Gruber 7.4

People in my neighborhood pay annual dues to a neighborhood association. This association refunds neighborhood dues to selected homeowners who do a particularly nice job in beautifying their yards.

a. Why might the neighborhood association provide this refund?

If the neighborhood association provides a refund to homeowners who do a nice job beautifying their yards, they are providing an incentive for other neighbors to beautify their own yards and a subsidy to make the neighborhood beautiful. By providing more of this good, they provide with a positive external social benefit for the whole neighborhood.

The neighborhood association collects annual dues with the purpose to provide external social benefit. If the neighborhood looks nicer, the value and price of all properties there will increase and everyone is better off.

b. At the most recent home owners’ association meeting, home owners voted to end this practice because they felt that it was unfair that some people would not have to pay their share of the costs of maintaining the neighborhood. What is likely to happen to the overall level of neighborhood beautification? Explain.

The overall level of neighborhood beautification will be reduced because the private incentive to beautify the neighborhood will end as the refund that the neighborhood association provides to those neighbors who beautify their garden ends. This is because the refund was an incentive to beautify gardens and when the refund is eliminated, there is no other reward for people to provide this positive externality and this people who stop beautifying their yards will start free riding on those who do still provide this positive externality.