Question

Assume there is a city of 1,000,000 people, 60 % of whom are willing to pay $1 maximum (each) to clean up pollution. The rest of the population is wealthier and is willing to pay $100 each to clean up pollution. Pollution clean up will cost $2,000,000. It has been proposed that each person be taxed equally to pay for the pollution clean-up.

Will that pass a majority rule vote?

Is it desirable from the point of view of the Pareto criterion?

Is it a good idea, using the compensation principle?

Which social choice mechanism do you think is best on intuitive grounds, and why?

Answer 1

1) Will that pass a majority rule vote?

Answer: When each individual is taxed equally, then each resident must pay $2. A vote on this proposition would fail to benefit a majority because 60% of the population is willing to pay a maximum of $1 to reduce pollution, and thus would vote against the proposition as the cost of the tax exceeds the gain.

2) Is it desirable from the point of view of the Pareto criterion?

Answer: By applying the same logic as in question-1, the proposal does not satisfy the Pareto criterion because 60% of the population would be made worse off by the policy.

3) Is it a good idea, using the compensation principle?

Answer: This is a good proposal with using the compensation principle. Using the compensation principle, if we split the cost of cleanup then people who approve of the result are ($100-$2) of surplus each, thus the total surplus equals $39,200,000 ( =0.4 * $98* $1million); and amount of loss who do not approve is $600,000 ( =$1*0.6*$1million). The 40% of the residents that are made better off by the proposal (individuals who are willing to pay $100 for the clean-up) could give sufficient compensation to the 60% of the residents made worse off by the proposal in order to benefit their support

4) Which social choice mechanism do you think is best on intuitive grounds, and why?

Answer: Economists often prefers the compensation principle which is based on the intuition that if the sum of the willingness to pay for a project in society exceeds the cost of that project, then it should be undertaken. In this way, the principle splits the desirability of a project from its proposed financing.