A person named Leslie lives in Metropolis and likes to rasie goats (G) for milk,

Question

A person named Leslie lives in Metropolis and likes to rasie goats (G) for milk, grass mowing, and company. Unfortunately, her neighbor named Lee finds the noise of the goats very annoying. The total welfare of each neighbor as a function of the number of goats that Leslie keeps is:

(a) i) If Leslie and Lee do not negotiate, how many goats will Leslie keep?

ii) If Leslie and Lee can negotiate about this dispute, how many goats will Leslie keep after negotiations? What is the total welfare gain resulting form the negotiations?

iii) Which neighbor will pay the other one to accept this arrangement, and how large will the payment be? (Calculate a range of possible payments).

(b) Suppose Metropolis changes the rule, and now people can't raise livestock without written permission from their current neighbors. How does that change your answer to parts (ii/iii) about the number of goats after negotiation, which neighbor pays, and how big the payment is? Explain briefly- no calculations are necessary.

Explanation / Answer

(a)

i. Raising livestock such as goat imposes cost to the neighbor. The goat here has negative externalities. Then according to the Coase theorem the social efficient allocation can be reached. In this case if Lee have right to choose the number of goats it will raise, it will choose a number that will give him the highest level of welfare. So he will raise 5 goats at equilibrium.

ii. If Leslie and Lee can negotiate they will end up at a equilibrium where the welfare of the two parties are same welfare. This occurs at the number of goats is 3. The welfare each party will get is 40.

The total welfare gain of Lee is 40.The total welfare loss of Leslie is (60-40)=20

iii. As the property rights over the livestock is not defined and anyone can raise livestock in their own property, to restrict Leslie, Lee should pay him. The payment should be between the loss in welfare of Leslie and gain of Lee. Then the possible range will be between 20 and 40.

(b)

Now suppose the property right is defined in favor of Lee. Then to raise the livestock Leslie need permission from Lee. In that case Leslie has to pay Lee for the loss of welfare. The number of goats Leslie can raise is also determined through negotiating with Lee.

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