Reference no: EM1332678

Home improvements

In Lakedale, Florida, a local "independent contractor: - Charles Home Improvement - bid on a contract to be the exclusive installer of hot water heaters sold by a big retail supplier of replacement water heaters in homes. The market for replacement water heater installation in Lakedale is a perfect competition market with many firms willing and able to install replacement water heaters, so independent water heater installers were not making any economic profit. The cost of replacing water heaters includes the cost of disposing of the old heaters in a responsibly environmentally safe way at a cost of $50 per heater, as required by county ordinance. Market prices for installing a replacement water hear ranged between 370 and $400 per heater. No independent installers were making any economic profit at these prices. Charles Home Improvement's winning bid was $370 per water heater. Charles prospered under the contract, apparently making good profit. People in the business wondered how he could be so efficient. This went on for several years.

One night a reporter got a tip that a pickup truck was observed in the dead of the night dumping something in the lakes. Th e reporter got his newspaper to fund an operation to explore the lake. Dozens of rusted out water heaters turned up. Pictures were taken and the story made it to the news paper.

After the story appeared in the newspaper, Charles Home improvement was often seen at the city dump paying the $50 free per water heater for disposal. When his contract came up for renewal with the big retailer, Charles asked for a substantial increase in his price for installing water heaters, claiming that he was now making a loss on every water heater he installed. His contract was not renewed.

Using "u" shaped average and marginal cost curves, and a demand and marginal revenue curve, show in a diagram the "no economic profit" point of output (numbers of water heaters installed per week) for ABC water heater inc in Lakedale. Label the ABC water heater inc. cost curves as TAC abc and MC abc

Label that output as Qabc. Assume that ABCWater heater sets a price of $380 per water heater installed.
Now assume that Charles Home improvement, when the disposal cost of old water heaters is included, has exactly the same average and marginal cost curves for installing replacement water heaters as does ABC water heater. Also, assume that Charles home improvement faces the exact same demand and marginal revenue curves as does ABC. Then in the same diagram you used to show the ABC water heater inc. output of water heaters installed per week, show Charles home improvements "u" shaped average and marginal cost curves, ABSENT the cost of disposing the old water heaters. Show Charles Home Improvement level of output as Q charles and indicate the area on the diagram (by shading or by hash marks and indicating with an error) that would be charles' profit, absent the disposal cost. One might say that Charles' profit that he was earning when not paying for proper disposal of old water heaters was caused by an "externality", similar to a steel mill dumping mill waste into a nearby river. Explain.