Econ 211 Problem Set 4 Sample Answers

9. Mosquitoville. 

a) Under majority rule voting, only Scooter would vote for spraying since
he values the mosquito-free environment at $100 and it would only cost him
$35 to get it done; Heather and Angela would not vote for the spraying
since the cost exceeds their value.  The fact that the spraying would not
take place is an inefficient outcome. From society's point-of-view the
benefit from a mosquito-free environment is more than the total cost of
spraying:  benefits = $120 > costs = $105.

b) Unanimity in favor of spraying could be achieved if negotiation is
costless.  Since Scooter places such a high value on a mosquito-free
environment, he would be willing to "bribe" the other two to go along with
the plan to spray.  For example, if the o ther two would pay an amount
equal to their values, Scooter could pay the rest of the amounts to meet
the $105 spraying bill.  Thus Scooter would end up paying around $85 (=34
+ 16 + 35) for something that is worth $100 to him.  Another example of
the Co ase Theorem at work! 

15.  Pollution on the lake: 

a) If nothing is done, each firm would go on polluting to the maximum. 
Thus 50,000 tons would be emitted. 

b) The price of a permit would be $150 since this is where the supply of
permits crosses the demand for permits. 

c) The price of a permit would be $400. 

d) The price of a permit would be $1000. 

e) The price of a permit rose as the government reduced the amount of
allowable permits. 

18. Factory Sludge. 

	sludge damage = $4000 (increased cost to fishermen) 
	factory filter = $3500
	weighted nets = $2750

a) If the factory is not liable and transactions costs are zero, then we
would expect the two parties to come to a bargain. To avoid the sludge the
fishermen could bribe the factory to install a water filter which would
cost $3500.  However, it would be b etter for the fishermen to simply
purchase the less expensive weighted nets for $2750. 

b) If the factory is liable and transactions costs are zero, then we would
still expect the fishermen to purchase the less expensive weighted nets.
In this case, though, the factory would end up paying for the nets on
behalf of the fishermen since it is c learly cheaper than installing a
water filter. 

c) If a tax is levied such that the proceeds go to the fishermen as
compensation (a potential $4000), we would expect the factory to look for
a cheaper alternative than paying the tax.  In this case, since
transactions costs are prohibitive, the factory can not simply bribe the
fishermen to use the weighted nets. Instead, the factory must install a
water filter system costing $3500 (which is cheaper than paying a $4000
tax). 

d) Thus the first two cases suggest that no matter who has the property
right, when transactions costs were zero we get the same result: the most
efficient solution is implemented - using the weighted fishing nets. 
However, if transaction costs are subst antial, there is still an
incentive to avoid the tax by finding a cheaper solution. 

19. Dolphin free tuna? 

a) The free market (which ignores the externality) would produce 6,000,000
tuna at a price of $3.00 since this is where the demand crosses the supply
(private marginal costs). 

b) The socially optimal outcome is at 3,000,000 tuna and a price of $4.50
since that is where the demand crosses the social cost curve. 

c) The optimal Pigou tax is equal to the external cost at the optimal
output level.  Thus a tax of $2.25 is neccessary.  The consumers of tuna
would end up paying $1.50 of the tax.  This represents the increase in
price paid from the free market price to the price which occurs at the
social optimum. 

d) Applying the Coase theorem, if property rights are well-defined and
transactions costs are minimal, the two parties, tuna fisherman and
dolphin lovers, could potentially reach a mutually beneficial agreement. 
Alternatively, perhaps the government coul d impose per dolphin fines on
the fishermen or simply impose catch limits on the tuna fishermen. 

25. If the discount rate is 7 percent: 
	
Net present value of the project = 300,000/(1.07)  + 300,000/(1.07)2 +
	300,000/(1.07)3 - 670,000

NPV = 280,037 + 262,031 + 244,889 - 670,000 = $116,957

	If the discount rate is 8 percent: 
	
Net present value of the project = 300,000/(1.08) + 300,000/(1.08)2 +
300,000/(1.08)3 - 670,000

NPV = 277,777 + 257,201 + 238,149 - 670,000 = $103,127

In both cases the project should be undertaken. 

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