Question

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 chemical plant that dumps industrial waste into the river. This pollutes the river and makes it a less desirable vacation destination. That is, the chemical plant's waste decreases the resort's economic profit.

  

Suppose that the chemical plant 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 chemical plant uses the recycling method, then the chemical plant's economic profit is $2,500 per week, and the resort's economic profit is $2,500 per week. If the chemical plant does not use the recycling method, then the chemical plant's economic profit is $2,800 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 chemical plant's economic profit and the resort's economic profit combined) with and without recycling.

Action	Profit
	Chemical Plant	Resort	Total
	(Dollars)	(Dollars)	(Dollars)
No Recycling	2,800	1,700
Recycling	2,500	2,500

Total economic profit is highest when the recycling production method is __________(not used/used)

When the chemical plant 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 chemical plant to recycle water. However, the recycling method decreases the chemical plant's economic profit by $2,800−$2,500=$300$2,800−$2,500=$300 per week. Therefore, the chemical plant 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 chemical plant will _________(not use/use) the recycling method and will pay the resort _________($0/ between $0 and $500/between $300 and $800/between $500 and $300) per week.

Now, suppose the chemical plant 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 chemical plant will _________(not use/use) the recycling method, and the resort will pay the chemical plant _________($0/ between $0 and $500/between $300 and $800/between $500 and $300) per week.

The chemical plant will make the most economic profit when ____________(the resort has propery rights to a clean river/it has property rights to pollute the river)

True or False: The chemical plant will use the recycling method, regardless of who has the property rights.

True

False

Answer 1

	Profit
Action	chemical plant($)	Resort ($)	Total ($)
No recycling	2800	1700	4500
Recycling	2500	2500	500

Total economic profit is highest when recyclimg production method is used.

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When the chemical plant uses the recycling method, the resort earns $800 (i.e., $2,500−$1,700) more per week than it does with no recycling. Therefore, the resort should be willing to pay up to $800 per week for the chemical plant to recycle water.

However, the recycling method decreases the chemical plant's economic profit by $300 (i.e., $2,500−$2,800) per week. Therefore, the chemical plant should be willing to use the recycling method if it is compensated with at least $300 per week.

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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 chemical plant will USE the recycling method and will pay the resort $0 per week.

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Now, suppose the chemical plant 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 chemical plant will USE the recycling method, and the resort will pay the chemical plant between $300 and $800 per week.

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The chemical plant will make the most economic profit when it has property rights to pollute the river

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TRUE: The chemical plant will use the recycling method, regardless of who has the property rights.

Explanation: The chemical plant will use the recycling method, even if it has property right given it gets adequate compensation.