Question

A beekeeper produces pots of honey and they are sold at a price of $2 per pot (i.e. the marginal benefit for honey is perfectly elastic). Of course, the production process of honey requires bees. The beekeeper’s bees provide an external benefit to a neighbouring orchardist. In fact, each additional pot of honey produced provides a marginal externality of 50 cents.

For the following questions assume that the private marginal cost is upward sloping.

1. Initially assume there is no bargaining between the beekeeper and the orchardist. Would the private optimal level of honey production be socially optimal? Explain with the help of a diagram.
2. How might a subsidy be used to bring about the socially optimal level of production. For best results should the subsidy be paid to the beekeeper or the orchardist? Explain with the help of a diagram.
3. If bargaining were costless, would the subsidy be needed to bring about the socially efficient level of production? Explain

(Please write the answer clearly and the font is clear. Thanks!!!)

Answer 1

i. If there is no bargaining between the beekeeper and the orchardist,the private optimal level of honey production will not be socially optimal because it will only equate the marginal costs of the beekeeper and the price paid to him (Marginal benefits of the consumers) and not include the marginal external benefits of the orchardist. (i.e. beekeeper will only keep bees and produce honey until the price paid to him is larger or equal to his marginal private cost,in this case till his marginal cost is 2$)

ii. A subsidy can be used to lower the marginal private cost such that it attains socially optimal level when it becomes equal to the marginal private benefit =2$. For best results the subsidy will have to be paid to the beekeeper who is producing the honey and keeping bees.

iii. If bargaining were costless, The orchardist and the beekeeper can come to an agreement that brings about the socially optimal level of quantity without the need of a subsidy(from Coase theorem which states that parties affected by an externality will bargain to reach the most efficient outcome if the transaction costs(in this case the bargaining costs) are zero)