Suppose a law is passed that prohibits farmers from using certain chemical fertilizers because the excess runs of and contaminates nearby ground water. The expected reduction in illness to water users is $10 million. The farmers experience an $8 million loss from switching to a more expensive fertilizer.
a. Does the introduction of the law represent a Pareto improvement relative to the status quo? Is it a Kaldor-Hicks improvement? Explain.
b. Now suppose the government taxes water users and uses the revenue to fully compensate farmers for their losses. Is the law now a Pareto improvement? Is it a Kaldor-Hicks improvement? Explain.
Answer a)
Since the law makes farmers worse off & the water users are now better off, so this situation is not a Pareto improvement, rather the two situations ( one after law & other before law represents the Pareto efficiency).
Now this situation is a Kaldor Hicks improvement bcoz the winners after reallocation of resources could hypothetically compensate the losers .since water users get $ 10 million & farmers loose $8 million, thus hypothetically water users could fully compensate & still the welfare of water users rise.
Answer b)
Yes this situation is now Pareto improvement , bcoz no body is made worse off & at least one agent has been made better off
Water users still get $ 2 million profit , after fully compensating for $ 8 to farmers.
This is now not the Kaldor Hicks improvement, after the compensation has been done, no further hypothetical compensation is possible
Suppose a law is passed that prohibits farmers from using certain chemical fertilizers because the excess...