Worksheet: Externalities and Pigouvian taxes revisited

Part 1:

Original information: A fishing resort owns 1/2 of the shoreline of a small private lake. A chemical factory owns the other 1/2. If the chemical factory does not pollute the lake, the fishing resort earns $50,000 of profit per year. If the chemical factory does pollute the lake, it kills most of the fish, and the fishing resort profit falls to $10,000 of per year. The chemical factory earns $50,000 of profit per year if it pollutes the lake, while it can produce its output without polluting the lake if it leases pollution-control equipment for $30,000 per year.

Question: What is the efficient outcome under these circumstances?

Part 2:

Additional information: If the factory pollutes the lake, the fishing resort can switch to a horseback-riding resort and earn $40,000 of profit per year.

Step 1: Complete the following "joint benefits table" showing how both the resort and the factory each fare under each possible combination of choices:

Step 2: Answer each of the following:

(1) Which is the most efficient set of choices?

(2) Which set of choices will result from a $40,000 Pigouvian tax?