Suppose your neighbour likes to repair motorcycles in his front yard during even

Question

Suppose your neighbour likes to repair motorcycles in his front yard during evenings and on weekends, and he earns $400 per week from this work. However, the sight of piles of greasy motorcycle parts and the additional noise and traffic caused by his customers reduces your value of living in this neighbourhood by $300 per week. If your neighbour has a right to operate this business, what is the efficient outcome? If you have a right to live in peace and quiet, how can you achieve the efficient outcome? If you have a right to live in peace and quiet, but have to hire a lawyer to bargain for you, what is the maximum you should spend on the lawyer to achieve the efficient outcome?

Explanation / Answer

It is a problem on externality. Normally when a person produces commodities, the good or bad effect is enjoyed by the producer himself. But in externality this effect extends to outsiders also. Suppose a factory has been constructed. It exerts some harmful gases and pollutes the air. Local residents health get affected due to such pollution. It is externality. This externality is negative. It can be positive when outsiders are benefitted from it.

In this problem, a neighbour has deecided to repair motorcycles in the front yard during evening and on weekends. He can earn $400 from this activity. But due to piling of greasy motor parts and noise caused by customers, value of living is reduced by $300 per week. It is negative externality.

Basic objective of neighbour will be to maximize profit. In determining profit maximizing repair work, he will consider only his own cost of repairing the motorcycles. Externality effect will be ignored. If neighbour has the right to operate this business, then his effecient outcome will yield a return of $400 per week.

Now suppose others have the right to leave in peace. Then neighbour can produce only when loss of others caused from externality effect is compensated in full. It is $300. So after compensating it, net profit is $100. So neighbour has to achieve an outcome where its weekly revenue is $400-$300=$100.

Now suppose you have to appoint a lawyear to bargain. In that case, you can pay maximum amount of $300 as remmuneration to him for achieving effecient outcome.

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