Consider a city with a lake. The city has a hiking lodge whose visitors use the

Question

Consider a city with a lake. The city has a hiking lodge whose visitors use the lake for recreation. The city also has a tannery that creates industrial waste, which it dumps into the lake. This pollutes the lake and makes it a less desirable vacation destination. That is, the tannery's effluent decreases the hiking lodge's profit. Throughout this problem, assume that negotiations are costless Suppose that the tannery could use an alternative production method involving water recycling. This would reduce the pollution in the lake to levels safe for recreation, and the hiking lodge would no longer be affected. If the tannery uses the recycling method, then the tannery's profit is $20,000 per week, and the hiking lodge's profit is $19,000 per week. If the tannery does not use the recycling method, then the tannery's profit is $23,000 per week, and the hiking lodge's profit is $15,000 per week Total profit (the tannery's profit and the hiking lodge's profit combined) is highest when the recycling production method is When the tannery uses the recycling method, the hiking lodge earns $19,000 $15,000- $4,000 more per week than it does with no recycling. Therefore, the hiking lodge should be willing to pay up to $4,000 per week for the tannery to use water recycling. However, the recycling method decreases the tannery's profit by $23,000 $20,000 - $3,000 per week. Therefore, the tannery should be willing to use the recycling method if it is compensated with at least $3,000 per week Suppose the hiking lodge has the legal rights to the lake. That is, the hiking lodge has the right to a clean (unpolluted) lake. In this case, assuming the two firms can bargain at no cost, the tannery will recycling method and will pay the hiking lodge the per week Now suppose the tannery has the legal rights to the lake, including the right to pollute it. In this case, assuming the two firms can bargain at no cost, the tannery will the tannery the recycling method, and the hiking lodge will pay per week Which of the following statements are correct? Check all that apply The hiking lodge will make the most profit when it has legal rights to a clean lake, and the tannery will make the most profit when it has the legal rights to pollute the lake The tannery will only use the recycling method if it has the legal rights The lake will remain polluted regardless of who has the legal rights

Explanation / Answer

Total profit (the tannery's profit adn the hiking lodge's profit combined) is highest when the recycling production method is used. Because When recycling production is used , total profit = $(20,000 + 19,000) = $ 39,000 per week while when recycling production is not used , total profir = $(23,000+ 15,000) = $38,000 per week.

Suppose the Hiking lodge has the legal rights to lake.. That, is the hiking lodge has the right to clean (unpolluted) lake. In this case, assuming the two firms can bargain at no cost, the tannery will use the recycling method so that the resort will earn $4000 more and will pay the hiking lodge $3000 per week.

Now suppose the tannery has the legal rights to the lake , including the right to pollute it . In this case , assuming the two firms can bargain at no cost , the tannery will use the recycling method and the hiking lodge will pay the tannery upto $3000 per week.

The hiking lodge will make the most profit when it has legal rights to clean lake and the tannery will the most profit when it has the legal rights to pollute it . (this statement is correct).

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