Question

The effects of property rights on achieving efficiency Consider a lake found in the village of Sturbridge, and then answer the questions that follow. The village has a hiking lodge whose visitors use the lake for recreation. The village also has a chemical plant that dumps industrial waste into the lake. This pollutes the lake and makes it a less desirable vacation destination. That is, the chemical plant's waste decreases the hiking lodge'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 lake to levels safe for recreation, and the hiking lodge would no longer be affected. If the chemical plant uses the recycling method, then the chemical plant's economic profit is $1,500 per week, and the hiking lodge's economic profit is $2,800 per week. If the chemical plant does not use the recycling method, then the chemical plant's economic profit is $2,300 per week, and the hiking lodge's economic profit is $1,600 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 hiking lodge's economic profit combined) with and without recycling.

Answer 1

By defining property rights and considering externalities, the chemical plant and hiking lodge's combined profit increases. Without recycling, the total profit is $3,900 per week; with recycling, it is $4,300 per week, thus recycling is the more efficient solution.

Step-by-step explanation:

The scenario presented involves a conflict of property rights leading to an externality, where the chemical plant profits by dumping waste into a lake, but at the cost of reducing profits for the hiking lodge because of pollution. The efficiency is improved when property rights are well-defined, as in the Coase theorem, encouraging the chemical plant to adopt more sustainable practices such as recycling water. This would increase the combined economic profit of both entities.

Without recycling, the chemical plant's profit is $2,300 per week while the hiking lodge earns $1,600 per week. Therefore, the total profit without recycling is:

• 
  
• Chemical Plant: $2,300
• 
  
• Hiking Lodge: $1,600
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• Total Profit: $2,300 + $1,600 = $3,900 per week

With recycling, the chemical plant's profit would be $1,500 per week and the hiking lodge's would be $2,800 per week. Therefore, the total profit with recycling is:

• 
  
• Chemical Plant: $1,500
• 
  
• Hiking Lodge: $2,800
• 
  
• Total Profit: $1,500 + $2,800 = $4,300 per week

Therefore, recycling increases the combined economic profit for both businesses, which aligns with the principles of economic efficiency when externalities are accounted for.