Question

8. The effects of property rights on achieving efficiency Consider a lake found in the village of Sturbridge, and then answer the questions that follow. The village has a hiking lodge whose visitors use the lake for recreation. The village also has a tannery that dumps industrial waste into the lake. This pollutes the lake and makes it a less desirable vacation destination. That is, the tannery's waste decreases the hiking lodge's economic profit. Suppose that the tannery could use a different production method that involves recycling water. This would reduce the pollution in the lake to levels safe for recreation, and the hiking lodge would no longer be affected. If the tannery uses the recycling method, then the tannery's economic profit is $2,000 per week, and the hiking lodge's economic profit is $2,900 per week. If the tannery does not use the recycling method, then the tannery's economic profit is $2,700 per week, and the hiking lodge's economic profit is $1,900 per week. These figures are summarized in the following table. Complete the following table by computing the total profit (the tannery's economic profit and the hiking lodge's economic profit combined) with and without recycling. Action Profit Tannery Hiking Lodge Total (Dollars) (Dollars) (Dollars) No Recycling 2,700 1,900 Recycling 2,000 2,900 Total economic profit is highest when the recycling production method is   . When the tannery uses the recycling method, the hiking lodge earns $2,900−$1,900=$1,000$2,900−$1,900=$1,000 more per week than it does with no recycling. Therefore, the hiking lodge should be willing to pay up to $1,000 per week for the tannery to recycle water. However, the recycling method decreases the tannery's economic profit by $2,700−$2,000=$700$2,700−$2,000=$700 per week. Therefore, the tannery should be willing to use the recycling method if it is compensated with at least $700 per week. Suppose the hiking lodge has the property rights to the lake. That is, the hiking lodge has the right to a clean (unpolluted) lake. In this case, assuming the two firms can bargain at no cost, the tannery will   the recycling method and will pay the hiking lodge   per week. Now, suppose the tannery has the property rights to the lake, including the right to pollute it. In this case, assuming the two firms can bargain at no cost, the tannery will   the recycling method, and the hiking lodge will pay the tannery   per week. The hiking lodge will make the most economic profit when   . True or False: The tannery will use the recycling method only if the hiking lodge has the property rights.

Answer 1