Problem Set 4 Answer Key

1.  This is in your notes and the text book.

2.  Parsons Guards I
a)    Guards provide a general sense of security for all residents that exhibits non-rivalry and non-exclusivity.
b)    The marginal cost of hiring a guard is greater than the marginal benefit to any single individual.
c)    See below.

3.  Parsons Guards II
a)    2 guards with a net benefit of $800.
b)    See table above. 
c)    Perhaps the Apartment Council could levy an annual security fee of $6 per resident to fund the 2 guards.

4.  Mosquito abatement program.
a) Under majority rule, only Charlie would vote in favor of the abatement program (since he values the program at $100, which is more than the cost to each owner of $35). Thus, the abatement program would not be approved. From society's point-of-view this would be inefficient since the total value of the program to the three guys ($120) is greater than the total cost ($105).
b) Unanimity could be reached by having Charlie subsidize Art and Bob's "tax bill." Assuming Art and Bob are willing to pay their values, Charlie could pay $34 on behalf of Art and $16 on behalf of Bob in order to pay for the abatement program. All parties would thus benefit.

5.  How would you argue?

6.  Tradable pollution permits create incentives for polluters to reduce their emissions by the least expensive methods available.  For example, if a polluter is allowed to emit only 100 units of pollution, then if they are able to reduce pollution through some inexpensive method, they can then sell their excess permits on the market and earn some extra revenue.

7.  Private costs = $10,000;  External costs = $5000 + 4000 + 1000 = $10,000; Social costs = private + external = $20,000

8.  Perhaps property values are lower around airports, thus housing is relatively cheaper.

9.  Fishermen and sludge.
a) The fishermen will buy the nets at a cost of $3250.
b) The factory will buy the nets for the fishermen at a cost of $3250.
c) The tax is likely to be set equal to the damage done by the sludge to the fishermen, namely, $5000. Given this potential tax liability, the factory will try to minimize its costs by avoiding the tax. Since the factory is precluded from bargaining with the fishermen as in part (b), they will be unable to buy the net system. The next best option is to install the water filter system at a cost of $4100 (which is better than paying $5000 in taxes).
d) As Coase would argue, the outcomes in parts (a) and (b) are identical: as long as property rights are well-defined and transaction costs are low, private bargaining will result in the most efficient outcome. In this case, efficiency requires that the nets be used. However, in part (c), transactions costs were high enough to prevent bargaining so that only a "second best" outcome prevailed.