Question

A. According to the Coase theorem, why would a Hobart zinc refinery that is legally allowed to emit pollution agree to reduce its pollution emissions even though it is not in its own private interests? How might transactions costs prevent this?

B. Suppose for every $1 of poppies grown in Tasmania that $0.05 of environmental damage is done from fertiliser entering river systems and other water ways. What type of externality is growing poppies causing? Explain why the social marginal cost of poppies is higher than the private marginal cost. Explain why the environmental damage from growing poppies causes a dead-weight loss. Suggest a market-based policy that will eliminate the dead-weight loss and how it will achieve the socially efficient level of poppies in Tasmania.

C. Suppose 3 kelp harvesters each send 1 boat each week to harvest bull kelp off Granville Harbour. Each boat returns with a harvest worth $1,150. It costs $1000 per boat per week to harvest the bull kelp. Every additional boat beyond 3 that is sent to harvest kelp results in the harvest falling by $50 per boat for all kelp harvesters. Why does an individual kelp harvester have an incentive to add another boat? Why is adding another boat not socially optimal?

D. Why do most economists advocate only using the tax/welfare system to address equity concerns from welfare analysis, rather than altering prices?

Answer 1

A. Coase Theorem states - "if trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights.” So in this case assuming negligible transaction cost, the company mgiht agree to reduce pollution if the stakeholder who is harmed by the pollutants or the government taxes beyond a certain limit of emissions. But if transaction costs increase because of this decision then they might resor to emit pollutiona gain in order to control their costs.

B. This is an example of negative externality. In such cases private cost is less that the social cost of adding every single unit of pollutant to the environment. So in this case of negative externality it imposes a cost of the society and hence social marignal cost is higher than marginal cost. The third party which is the society would suffer the damage. This excessive production would impose cost on the third party and thus create deadweight loss to society. Imposing pollution taxes can help reduce the pollution as it makes the cost higher for the firm to produce with the externality. One market based solution would be to increase prices of inputs required in the manufacture. Only then firms will be forced to raise prices, bring down demand and thus production would automatically come down and corresponding pollutants will fall.

C. Each kelp harvester who is now earning profit of $150, will earn $200 after adding one more boat .(if per boat harvest falls by 50 also they are gaining in gross). But it is socially suboptimal because ultimately it is causing pressure on harvest and bringing down harvest intensity and the boats will use fuel and add to pollution in the waters.

D. Altering prices could be socially costly. It will imposed burden on individual consumers and could bring down effective demand. This will negatively affect the market in long run. Also if prices are altered producers will gain at cost of consumers and monopolistic behavior will creep in.