QUESTION 3 (a) State the Coase Theorem. Discuss at least two reasons why this private solution to the problem of externalities may fail to apply. (2 points) (b) Consider the interactions between a chemical firm situated on the banks of a river and a fishery located downstream from the chemical firm. The chemical firm benefits from polluting the river while the fishery suffers from any pollution of the river. Specifically, let the marginal benefit of pollution C of the chemical firm be MBc = 40 C, and let the of pollution of the fishery be given by MCr = 10 + C. Suppose also that property rights favour the fishery. (i) What pollution level will the fishery choose in the absence of any bargaining? (1 point) (ii) If both parties bargain, what pollution level will emerge as a result of this mutually beneficial bargaining? As an outcome of the bargaining process, who will make a transfer to whom, and what is the minimum required level of transfer? Explain and provide a graphical representation. (2 points) Now suppose that the chemical firm does not know the fishery's true marginal cost curve. Instead, the fishery persuades the chemical firm that its marginal cost of pollution is MCFr = 10 + 2C rather than the true curve (given by MCFr = 10 + C). Property rights favour the fishery and bargaining takes place accordingly. (iii)What pollution level will be chosen through bargaining now? And what is the minimum required level of transfer? Explain and provide a graphical representation. (2 points) (iv)Does the fishery have an incentive to misrepresent the position of its marginal cost curve? If so, what is the gain to the fishery from misrepresenting the marginal cost curve when the minimum transfer identified in (b)(iii) is paid? What is the magnitude of the inefficiency of the Coasian solution when the fishery misrepresents its marginal cost curve? (3 points) QUESTION 4 (a) Which Arrow's Impossibility Theorem axiom is sacrificed to prove the median voter theorems? Provide a detailed justification. (2 points). (b) Consider the quasilinear utility function U =Y' T' +In G where Y'is the individual i's income. Tax revenues T' are used to finance aG. The cost of providing G units of tge public good - (G) - is G. There is an odd number N of individuals in this society. (i) Suppose that a poll tax T' =T for all i is levied on each of N members of society. Find the level of public good G obtained through majority voting. (3 points) (ii) Now suppose that a proprtic:-na T' =tY'is levied. Find the level of public good G obtained through majority voting. (3 points) (iii)Assume that the distribution of personal income is skewed, with the average level of income, Y, exceeding the median income, Y". Compare the voting outcomes found in parts (a) and (b). When is the voting outcome efficient? Explain why. (2 points) Page 5 of 4 PUBLIC SECTOR ECONOMICS (H/G) - (ECON4434/8034) QUESTION 5 In a transferable voting system each voter provides a ranking of the candidates. The candidate with the lowest number of first-choice votes is eliminated, and the votes are transferred to the second-choice candidates. This process proceeds until a candidate achieves a majority. (a) Assume sincere voting. (i) Explain what is meant by Condorcet winner and show, by means of an example different from those covered in class, that the transferable voting system may fail to select the Condorcet winner when one exists. (2 points) (ii) Explain what is meant by independence of irrelevant alternatives and show, by means of an example different from those covered in class, that the transferable voting system fails independence of irrelevant alternatives. (3 points) (iii)Explain what is meant by positive responsiveness and show, by means of an example different from those covered in class, that the transferable voting system fails positive responsiveness. (3 points) (b) Show how strategic voting can affect the outcome obtained in (a)(i). (2 points)