Anne has just purchased a new house in a lovely neighborhood. Her neighbors are friendly and even brought her house-warming gifts. Anne, however, has a problem. Her neighbors have cats, and Anne hates cats. Even though the city has a law requiring all outdoor pets to be on a leash, her neighbors ignore it, and the cats roam all over Anne's property. How would an economist describe this situation? Is there anything Anne can do?

An economist would say negative externalities are present if the neighbors' cats are imposing an external cost on Anne. She could report the lawbreakers to the police, and have Animal Control round up the cats, but this wouldn't be very neighborly. Her best bet might be to get together with her neighbors and negotiate a compromise. Since they are the only two parties to this problem, they have a good chance of working out a mutually acceptable agreement.