In: Economics
Assume a wind farm developer spent millions of dollars constructing wind turbines on land outside Mountain . Adjacent residents filed a lawsuit complaining that they never consented to the loud noise and visual obstructions of the turbine. The Mayor of Mountain proposes that the city place a tax on the turbines with the hope that will generate some much-needed revenue for the city and reduce the quantity of turbines.
A. Figure-1 in the document attached below illustrates the market for wind farms in the city of Mountain along with the trouble and discomfort faced by the city residents which constitutes the negative externality due to the turbine operation by the developer as part of the wind farm production. The price and quantity of the wind farms in the market represented by P(w) and Q(w) respectively. The market demand or the Private Marginal Benefit(PMB) of wind farms is represented by D(w) or the PMB curve which also designates the Social Marginal Benefit(SMB) of wind farms as well. The market supply of the wind farms by the developer is denoted by S(w) or Private Marginal Cost(PMC) curve in figure-1. Now, devoid of any direct or indirect government measure/s or preventive mechanism to alleviate or mitigate the impact of the negative externality, the equilibrium price and quantity of wind farms in the market would be P*(w) and Q*(w) respectively corresponding to the intersection of the D(w)/PMB/SMB curve and the S(w)/PMC curve in the market as depicted in figure-1. This equilibrium quantity of wind farms in the market denotes the socially inefficient or non-optimal quantity or output of wind farms as the market does not account for the damage or harm caused by the negative externality, in this particular case.
B. Now, figure-2 hypothetically illustrates the economic impact of the tax imposition proposed by the city mayor in the market for wind farms in Mountain. In this case, we can consider the original market supply curve of wind farms as S(w)1 or PMC curve prior to the tax imposition. As a result of the tax imposition, the marginal cost of wind farm production by the wind farm developer increases from S(w)1 to S(w)2 or the Social Marginal Cost(SMC) curve as indicated by an upward or leftward shift of the market supply curve of wind farms. The SMC in the wind farm market can be calculated as the summation or addition of the PMC and the Marginal Externality Cost or MEC which is the cost or damage caused by the negative externality generated by each turbine produced by the wind farm developer. The socially optimal tax rate is ideally equal to the MEC which essentially signifies that the developer compensates for the marginal cost or damage of the negative externality caused by the wind farm production. Following the tax imposition by the city, the equilibrium price and quantity of wind farms in the market increases from P*(w)1 to P*(w)2 and decreases from Q*(w)1 to Q*(w)2 respectively as shown in figure-2. Note that as the number or quantity of wind farms decreases in the market, the overall level of turbine operation by the developer would also simultaneously decline or reduce as its usage in the production process would decrease. This would consequently lead to an expected reduction in the level of the negative externality in the market and thus, the new quantity of wind farms in the market following the tax imposition can be considered as the socially efficient or optimal level of wind farms and the level of turbine operation in the market considering the overall positive welfare impact of the externality tax imposition by the city administration.
C. The wind farm developer could have ideally saved the quiet substantial financial loss because of the lawsuit filed by the residents in one of the areas in Iowa by entering into a mutual official agreement with the local residents who are affected by the negative externality caused by the turbine operation. Based on the Coase Theorem, both the concerned entities or the stakeholders, that is, the management of the developer company and the local affected residents could have thoroughly discussed about the mitigation of the externality issue or the problems faced by the affected residents and then come up with a mutual solution based on the demarcation of the respective property rights. In this case, on the basis of a mutually agreed estimation of the magnitude or the actual extent of the problems caused by the turbine operation by the developer, the developer management could have offered a reasonable compensatory amount to the local residents acknowledging that the private residences of these people constitute their legal private properties and hence, they are officially or legally entitled to any form of compensation due to any trouble or problem faced by them because of the operational activities of the developer. On the other hand, the developer also has the legal right or permission to conduct its operational or business functioning on the particular area which comes under its legal jurisdiction. Therefore, a mutual compensatory settlement between the local affected residents and the developer to allow the management to continue its operation could have saved the humongous financial loss incurred by it due to the operational shut down as per the court mandate or verdict. In this regard, it must be noted that such a mutual settlement between the concerned parties or entities is based on the assumptions of clear distinctions or demarcations of the property right of the respective parties and absence of any transaction cost associated with mutual bargaining/settlement or discussion. Under these assumptions and circumstances, the mutual agreement or the settlement between both parties could have ensured a pareto-optimal outcome or solution to the concerned externality issue.