Question

8. The effects of property rights on achieving efficiency

Consider a river found in the city of Philadelphia, and then answer the questions that follow.

The city has a resort whose visitors use the river for recreation. The city also has a tannery that dumps industrial waste into the river. This pollutes the river and makes it a less desirable vacation destination. That is, the tannery's waste decreases the resort's economic profit.

  

Suppose that the tannery could use a different production method that involves recycling water. This would reduce the pollution in the river to levels safe for recreation, and the resort would no longer be affected. If the tannery uses the recycling method, then the tannery's economic profit is $2,600 per week, and the resort's economic profit is $2,500 per week. If the tannery does not use the recycling method, then the tannery's economic profit is $2,900 per week, and the resort's economic profit is $1,700 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 resort's economic profit combined) with and without recycling.

Action	Profit
	Tannery	Resort	Total
	(Dollars)	(Dollars)	(Dollars)
No Recycling	2,900	1,700
Recycling	2,600	2,500

Total economic profit is highest when the recycling production method is   .

When the tannery uses the recycling method, the resort earns $2,500−$1,700=$800$2,500−$1,700=$800 more per week than it does with no recycling. Therefore, the resort should be willing to pay up to $800 per week for the tannery to recycle water. However, the recycling method decreases the tannery's economic profit by $2,900−$2,600=$300$2,900−$2,600=$300 per week. Therefore, the tannery should be willing to use the recycling method if it is compensated with at least $300 per week.

Suppose the resort has the property rights to the river. That is, the resort has the right to a clean (unpolluted) river. In this case, assuming the two firms can bargain at no cost, the tannery will   the recycling method and will pay the resort   per week.

Now, suppose the tannery has the property rights to the river, 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 resort will pay the tannery   per week.

The resort will make the most economic profit when   .

True or False: The tannery will use the recycling method only if the resort has the property rights.

True

False

Answer 1

		Profit
Action	Tannery (dollars)	Resort (dollars)	Total (Dollars)
No recycling	2,900	1,700	(2900+1700)=4600
Recycling	2,600	2,500	(2600+2500)=5100

When the recycling method is not used. total profit =$ 4600. And when recycling method is used ,total profit = $5100. This implies that when recycling method is used ,total profit is more by $400 than without recycling.

Hence, Total profit is highest when recycling production method is used.

Suppose the resort has the property rights to river.That is, the resort has the right to clean river. In this case, assuming the two firms can bargain at no cost, the tannery use the recycling method and will pay the resort $0 per week.

Because The recycling method decreases the tannery's profit by $300 per week. Therefore,the tannery is willing to pay the resort up to $300 per week to be allowed not to use the recycling method. But when tannery doesn't use the recycling method ,then the resort would earn $ 800 less per week. Therefore, resort would require atleast $800 per week to allow the tannery to pollute the lake by not using recycling method. Even if the tannery is offered to pay $300 per week, the resort would not consider allowing the pollution ,because a clean river is worth $800 per week to the resort. And because the resort own the right to clean river, the tannery's only choice is to use the recycling method . And because the river remains clean , so the tannery doesn't need to pay any money to the resort.

Now, suppose the tannery has the property rights to the river, including the right to pollute it.In this case, assuming the two firms can bargain at no cost, the the tannery will use the recycling method and the resort will pay the tannery between $300 and $800 per week.

Because the recycling method increases the resort's profit by $800 per week . Therefore, resort is willing to pay the tannery upto $800 per week to use the recycling method. But when the tannery uses the recycling method ,it earns $300 less per week. Therefore,the tannery will require at least $300 per week to use the recycling method.

The resort will make the most economic profit when the resort has the property right to the lake.

FALSE because , the tannery will use the recycling method in every case whether the property rights with resort or tannery.