Question

4. Suppose that Dr. Heart has his doctor's office in the same building as Mr. Graham's bakery. Unfortunately, for Dr. Heart, the noise from the bakery is very disruptive to both him and his patients, and this affects Dr. Heart's profit. Mr. Graham could use quieter machinery, but this would be costly and would lower his profit. The table below shows the annual profit for Dr. Heart and Mr. Graham depending on whether Mr. Graham uses noisy or quiet machinery. Note that there are currently no laws requiring the use of quiet machinery. Noisy Quiet MachineryMachinery $175,000 $200,000 $80,000 Dr. Heart Mr. Graham SI $100,000 A) Is it socially efficient for Mr. Graham to ase quiet machinery? Explain. B) If Dr. Heart and Mr. Graham cannot negotiate with each other, then will Mr. Graham use noisy or quiet machinery? Briefly explain. C) If Dr. Heart and Mr. Graham can costlessly negotiate with each other, then w raham use quiet or noisy machinery? IHow might this agreement be reached? Briefly explain.

Answer 1

(A) For finding out the socially efficient option, we can compare the total profits for both individuals in each case:
1. Noisy Machinery: Total Profits= 175000 + 100000 = 275,000
2. Quiet Machinery: Total Profits= 200000 + 80000 = 280,000
Hence, clearly, quiet machinery is socially efficient.

(B) If the two cannot negotiate, Mr Graham will use the noisy machinery as it yields higher profits for him, he will only be concerned with his own profits

(C) If the two negotiate, Mr Graham could be made to use quieter machinery by compensating him for the profit that he loses by using the quieter machinery.
As he loses 20,000 by using quieter machinery, Dr Heart could offer him 20,000 as compensation, after which he will be indifferent to the machinery being used. At the same time, Dr Heart''s profits would increase by 25,000, and after compensation, he still ends up with additional profits of 5,000.
So, this situation would be beneficial for both!

Hope it helps