Question

Externality: A restaurant owner is considering a ban on smoking in his restaurant. The table below lists the daily-expected benefits received by the owner from smokers and non-smokers. There are three choices, ban, allow or set up a separate smoking area. Assume all parties can negotiate at zero cost.

Ban Smoking	$200 (smokers)	$220 (non-smokers)
Allow Smoking	$280 (smokers)	$150 (non-smokers)
Separate Smoking Rooms	$210 (smokers)	$200 (non-smokers)

1. Suppose the restaurant owner has the property rights to allow, ban or provide a smoking area in the restaurant. What will happen? Explain.

2. Suppose the non-smokers have property rights to allow, ban or provide a smoking area in the restaurant. What will happen? Explain.

3. Suppose the non-smoking benefit for banning smoking increases from $220 to $250 per day. If smokers own the rights to smoke what will happen? Explain.

Answer 1

If restaurant owner has the property rights then restaurant owner will look into its own gain. If restaurant owner ban smoking then expected benefit of the restaurant owner is $200(from smokers) + $220(from non-smokers) = $420. If restaurant owner allow smoking then expected benefit is $280(from smokers) + $150(from non-smokers) = $430. If restaurant owner arrange separate smoking rooms then expected benefit is $210(from smokers) + $200(from non-smokers) =$410. If restaurant owner has the property rights then the restaurant owner will allow smoking because expected benefit from allowing smoking is more than the other two. So as $430> $420>410 restaurant owner will allow smoking.

If non-smokers have the property rights then non-smokers will ban smoking in the restaurant because the expected benefit for owner is highest when smoking is allowed. But as property rights belongs to non-smokers they will ban smoking. In this case owner of restaurant can negotiate with the non-smokers to allow smoking and for that owner will give maximum $10 to non-smokers to get the permission of smoking. Because in case of Banning smoking the owner was getting $420 and with smoking the owner's expected benefit is $430. So maximum amount owner will give to smokers for getting the permission of smoking is $10.

If non-smoking benefit for banning smoking increases from 220 to 250 per day and property rights belongs to smokers then total benefit of owner from baning smoking is $450(200+250) but with smoking the expected benefit for owner is $430(280+150). Now owner can negotiate with the smokers to ban the smoking so that owner can get highest amount. Owner of Restaurant will be ready to give maximum $20 to smokers to get a permission to ban the smoking in the restaurant.