II. I summed up Coase's analysis as consisting of three parts: Nothing works. Everything works. It all depends (on transaction costs). Pick one of the three, and explain that part of the argument in your own words.
I have already done all three in my words.
III. A factory pollutes a lake which is also used by twenty vacation resorts. It would cost the factory $1,000,000 a year to prevent the pollution. Each resort faces the following alternatives (remember that there are twenty resorts):
a: Operate as a resort on an unpolluted lake, making $100,000/year profit.
b: Operate as a resort on a polluted lake, making $40,000/year profit.
c: Operate as a hunting lodge, making $60,000/year profit, whether or not the lake is polluted
A. What is the efficient solution?
The factory should (pollute/not pollute)
The resorts should be operated as (resorts/hunting lodges)
pollute, resort=$800,000 to resorts
pollute, lodge=$1,200,000 to lodges
don't pollute, resort=$2,000,000 to resorts&endash;$1,000,000 pollution control cost to factory=$1,000,000
don't pollute, lodge$1,200,000 &endash; $1,000,000=$200,000
So on net, pollute and have lodges maximizes net benefit.
In answering parts B and C, describe first what happens if there is no bargaining between factory and resort owners, and then whether bargaining will change the outcome. Explain briefly.
B. The factory has the right to pollute if it wants to.
With no transactions, the factory pollutes, since it bears no cost from doing so but would have to pay the cost of pollution control. Since the factory pollutes, the resort owners maximize their return by converting the resorts to hunting lodges
With bargaining, the same thing happens. The cost to the factory of controlling the pollution is more than the benefit to the resort owners, so even if they could solve their public good problem and work together, the largest sum they would be willing to pay the factory not to pollute is less than the smallest sum the factory would accept.
C. Any resort can enjoin the pollution, so the factory can only pollute if it has permission from all the resorts.
There would be a net gain if the resorts all gave the factory permission to pollute, and it in exchange paid them at least $40,000 each to compensate them for the loss from having to operate as hunting lodges rather than resorts. But to get that gain requires unanimous permission of the lodges, so there may be a holdout problem, which may prevent the efficient outcome, in which case the result is no pollution and resorts.