Analysis and Optimization of Profits per month, Discharge waste, Grime, and more

1. Two firms are involved in a dispute: Grime pollutes a nearby river. The pollution travels downstream past IPA, a company that manufactures beer. Dumping its waste into the river cuts Grime’s waste-disposal costs, while increasing IPA’s water treatment costs. The profits of the two firms (both with and without waste dumping) are in the table below.

1. What are the total returns to both companies with and without dumping? Which situation (dumping or no dumping) is socially optimal? 
2. If there is no government intervention in the market, and the two companies do not communicate, will Grime dump waste into the river? Why or why not? 
3. What is the cost to Grime not to dump waste into the river? How much would IPA have to pay Grime to clean up the waste? 
4. What is the cost of pollution to IPA each month? How much would IPA be willing to pay Grime to stop dumping waste into the river?
5. If Grime and IPA could negotiate, at no cost, could they come to an agreement that would eliminate the externality problem and result in the efficient outcome? If not, why not? If so, what would the payment be? 
6. Does it matter who has the initial property right: Grime to dump or IPA to have clean water? Explain. 

[total 12 marks]

2. A sawmill owned by Smith can operate with or without soundproofing. Operation without soundproofing results in damage to Jones who is Smith’s neighbour. The relevant gains to Smith are: without soundproofing $150 per week; with soundproofing $34 per week. From Jones’ point of view the relevant damages are: without soundproofing $125 per week; with soundproofing $6 per week.
   1. If Smith is not liable for noise damage and there are no transaction costs, will Smith install soundproofing? Explain. 

1. How, if at all, would your answer differ if the transaction costs of maintaining an agreement were $4 per week? Explain.

1. Now suppose that Jones can escape the noise by moving to a new location, which will cost Jones $120 per week. With transaction costs assumed to be zero, how, if at all, will your answer in (a) above differ? Explain.

3. Consider the situation where the products of creative artists – bands, writers, etc – are protected by copyright law. Market demand and supplyfor these products is represented by

  and .

1. Calculate the market equilibrium for creative work. 

• Now assume that there is some leakage – in the form of additional benefits - around existing copyright law. The marginal social benefit of creative work is described by . Note: this includes all benefits at the margin.

Calculate the socially optimal level of creative work. 

• Assume that the supply function does not change, what are the net economic benefits from “leak-proofing” copyright law? Calculate the change in surplus accruing to the artists and consumers. Illustrate your results using a suitably labelled graph
• If we recognise that “transaction costs” should be taken into account; at what = would transaction costs have to be to make internalisation uneconomic?