Answer these questions at home and bring to class on Monday morning, Oct. 8. Be prepared to compare your answers with those of other students in your study group.

1. A public bus system operates in the Greater Olympia region. You can ride the buses between Evergreen, downtown and other residential and shopping locations. In general, the fare riders pay covers only part of the cost of transportation; students and employees of the college can even ride for free. The difference, of course, is made up by public tax contributions.

a. What are the main social costs and social benefits of the bus service, using these terms as they are defined by economists?

b. Do you think the assumptions of the Market Welfare Hypothesis apply in this case? Why or why not? What implications does your answer have for the appropriateness of public subsidies? Explain.

2. Suppose that a parcel of land adjoins a lake. On land there is a pulp-and-paper mill; the lake is stocked for fish, which are harvested and sold. The mill pollutes the lake and reduces the amount of fish that can be grown there. This pollution can potentially be reduced by installing pollution control devices, numbered from one to six in order of increasing cost. (In other words, an initial quantity of pollution can be reduced by using a relatively cheap process; to reduce more pollution requires a more expensive intervention, etc.) The mill and the lake are owned by separate business interests.

The following table shows the annual operating profits for each enterprise based on the number of pollution control devices installed. As more pollution is controlled the mill becomes less profitable due to the expense of the various devices, while the fishery becomes more profitable due to improved water quality.
 

a. Suppose that the mill owner has the legal right to pollute as much as she wants and begins to operate with no control devices. If the fishery owner is able to negotiate, and if both parties act in their narrow self-interest, how many control devices will end up being installed?

b. What will be the range (lowest to highest) of potential payoffs from the fishery owner to the mill owner?

c. Based on your answer to (b), what are the potential ranges of profitability (combining operations and payoffs) for both enterprises?

d. Now suppose that a court rules that there can be no pollution unless the fishery owner willingly agrees to it. If both parties negotiate in a self-interested fashion, how many pollution control devices will end up being installed?

e. What will be the range (lowest to highest) of potential payoffs from the mill owner to the fishery owner?

f. Based on your answer to (b), what are the ranges of profitability (again combining operations and payoffs) for both enterprises?

g. Sometimes the Coase Theorem is interpreted to say that "It doesn't matter what the initial assignment of right is. If the rights are unambiguous, and if the parties are free to negotiate, the allocation of resources [in this case the amount of pollution occurring] will be the same in either case." Does the above example support this hypothesis?

3. Is the Coase Theorem consistent with the Safety Standard, as explained by Goodstein? Explain.