Reference no: EM1399767

CASE

A beautiful harbor town has the following characteristics:

• It is located on an island that is mostly (except for the town) a nature preservation area, including a coastline and underwater preservation area. The island is owned by a nonprofit foundation established 100 years ago by a wealthy land investor who bought the island from the government at a low price. The foundation's purpose is to protect the natural environment of the island for future generations to enjoy. It is supported by revenue from rents in the town and fees charged to arriving passengers and ships.
• The harbor town's economy is almost entirely devoted to a thriving tourist trade. All tourists arrive on ferries, yachts, or cruise ships, since there is no commercial airport. The economy consists of restaurants, gift shops, art galleries, hotels, bed-and-breakfast lodgings, and so forth.These businesses lease property from the foundation that owns the island. Visiting ships and yachts must pay a fee to dock or anchor.
• One of the harbor's attractions is an aquarium with an undersea viewing window. Another is a group of passenger-carrying submarines with observation windows. People also rent equipment and lessons in the town to go kayaking and snorkeling in the nearby coastline preservation area.
• Although it is a major tourist attraction, the island competes with hundreds of other attractions in the same region. It is more costly to visit than most places because it is so remote and because the foundation charges high rents for the land in the town and for docking ships.
• The tourist trade is declining because the water is starting to turn brown and stink, and the underwater life in and near the harbor is dying. Research finds that this is happening because of the sewage pumped out of holding tanks by ferries, yachts, and cruise ships. Such dumping is illegal, but it is common because it is so hard to identify which vessel is the source.

The governing board in charge of the island hears three proposals.

i) Shut down the tourist industry and close the town, in order to preserve the natural habitat of the island. Some argue that this is consistent with the purpose of the foundation, even though it would take away the revenue of the foundation for maintaining the island.

ii) Charge a higher fee for all passengers arriving at the island, in order to preserve both the natural habitat and the beauty of the harbor town.

iii) Have island officials place red dye tablets in the toilets and holding tanks of all ships, yachts, and ferries visiting the island. This will instantly show which ones are dumping sewage, and will mark those boats and ships with big red streaks.

Questions:

a) Describe the status quo in the town in simple micro-economic terms. Assume that tourism on the island is a single good even though it consists of many different services and activities, and that boating and shipping to the island is another single good. Also assume that these two industries (tourism on the island and transportation to the island) are competitive markets, even though they pay rents to the foundation that owns the island. What can you say about these two markets and their relationship to each other? What can you say about total private and public surplus? Who gains and who loses from the practice of dumping sewage from ships?

b) Describe the likely impact of each of these three proposals on total surplus including social cost and benefit (i.e., economic efficiency).

c) Which of these proposals is most consistent with the Coase approach to externalities, and why? (It's not a perfect example of the Coase theorem, but what features does it share with the Coaseapproach?