Question

1. Suppose there is a bee farm and an apple farm adjacent to each other in Village A. The bee farmer produce honey by raising bees, which creates external benefits for the apple farmer because bees help improve pollination of apple trees. Suppose that the bee farmer has the profit-maximizing output level as raising 10 units of bees, bringing $600 of profits by selling the honey. With 10 units of bees helping the pollination, the apple farmers have $400 of profits. 20 units of bees bring $450 of profits for the bee farmer but bring $650 for the apple farmer. The bee farmers have the property right over the bees.

	Bee farmer profit	Apple farmer profit	Social profit
10 units of bees	$600	$400
20 units of bees	$450	$650

1. (3 points) Fill out the blanks for social profit. Which outcome is more desirable in terms of maximizing social welfare?
2. (2 points) What would the outcome be without any intervention or negotiation?
3. (4 points) Suppose that the apple farmer can negotiate with the bee farmer and the cost of negotiation is negligible. Under Coase Theorem, can you provide one possible agreement in which the bee farmer will agree to increase the use of bees to 20 units? Make sure you list the amount of payment if it occurs.
4. (3 points) Under the agreement mentioned in part c, what is the bee farmer’s profit? What is the profit for the apple farmer? Is the social profit efficient under this agreement?

Answer 1

Answer a) Social profit for 10 units of bee = 600 + 400 = $1000
Social profit for 20 units of bee = 450 + 650 = $1100
Social profit in economics means accounting profit plus or minus profit or loss due to any positive or negative externality. In this case bees help in pollination of apples thus creating a positive externality.

Answer b) Without intervention or negotiation 10 units of bee will be produced because it maximizes the profit for bee farmer.

Answer c) Coase Theorem is an economic and legal theorem that says when there are positive or negative externalities, and there are no costs involved parties tend to chose the most efficient production option.
One possible agreement by which bee farmer will be ready to produce 20 units is that the profit arising from it will be shared with him. For example due to production of 10 units of extra bees apple farmer increases his profits by 250 dollars and bee farmers profit decreases by $150. So one of the possible arrangements may be that apple farmer gives $200 profit to bee farmer so as to cover his loss and share the $100 dollar worth extra profit.

Answer d) In the agreement mentioned in c) Bee farmers total profit will become $650 and apple farmers total profit $450. Thus both will have additional benefit of $50 and social profit will be efficient.