Open Question 5
Lake L is situated near a village. In this task, we will consider different property rights regimes for the lake and explore their implications on the villagers' well-being and the environment.
Assume that the production function of the lake is f(x) = 100 x, where f is the total amount of fish (in kilograms) that can be caught in the lake per day, and x is the number of fishing nets used. A kilogram of fish can be sold in the market for $10, and the daily rental price for a fishing net is $25.
(a) (7 points) Suppose Firm A owns the lake and has exclusive fishing rights. It does not have any cost besides fishing nets rental. Calculate the amount of fish that it will catch to maximize profits.
(a) The firm's profit is Profit(x) = 10 \times 100 \sqrt{x} − 25x. It is maximized at x = 400 and f(x) = 2000.
(b) (6 points) Now, suppose Firm A makes money by charging villagers a per-net fee to fish in the lake, rather than selling the fish directly. Assume that all fishermen fish with the same intensity, collectively catching the maximum possible fish with the given number of nets and selling it in the market. In addition to the per-net fee charged by Firm A, each fisherman must pay $25 per day to rent a net. What will the per-net fee be?
(b) The lake owner can basically collect all (or almost all) the profit that fishermen will earn from selling fish, the maximum of which will be equal to profit that it used to earn by selling fish itself. So, it should sell 400 fishing nets licenses and let the villagers catch 2000 kilos of dish per day. Every net catches 5 kilos of fish that can be sold for $50, so the profit from one net is $50 − $25 = $25. A profit-maximizing lake owner should charge this amount (or slightly lower).
(c) (7 points) The government decides to nationalize the lake, making it open-access for the villagers. Now, every villager can fish using one or more nets, which still need to be rented for $25 each. Assuming each villager only considers their own benefit, determine the number of nets that will be used and the total amount of fish that will be caught. Compare your answer to parts (a) and (b) and explain the differences.
(c) Now, every fisherman will decide to rent a fishing net in case it brings more revenue than its rental cost. Therefore, additional nets will be used until profit reaches zero. That is, Profit(x) = 10 \times 100 \sqrt{x} − 25x = 0. This brings x = 1600. More nets are used and more fish is caught because the fishermen fail to internalize the externality that exists here: due to diminishing returns, adding each net makes the situation worse for every existing net, but a fisherman in this situation does not care. In parts (a) and (b), there was a 'central planner' (Firm A), which internalized the externality, because it maximized overall profit and had no incentives to overfish.
(d) (4 points) What are the likely long-term consequences for the fish population in the lake? What is the economic term for the problem that arises in this situation?
(d) This will likely cause excessive fishing (overfishing), which can lead to the ecosystem of the lake being destroyed (the fish just won't be able to reproduce). The lake is a common-pool resource, and the problem is called 'the tragedy of the commons' 1 in economics. Other relevant terms are: the free rider problem, the prisoner's dilemma, negative externality.
(e) (6 points) If you have solved the previous parts correctly, you will find that the economic position of the villagers (the fishermen) is unfavorable under both private and public ownership of the lake. However, there is hope. Elinor Ostrom's research highlights that community members can successfully manage common-pool resources through cooperation and the establishment of social norms, even with limited or no official government regulation. Suggest two principles for designing these norms and institutions to enhance their effectiveness. Explain the importance of each principle in ensuring the sustainable and efficient use of common-pool resources. You can either rely on Ostrom's research or suggest your own principles.
(e) Some of these principles may be suggested 2 :
Clearly defined boundaries. The boundaries of the resource system, such as a fishery, and the individuals or households with rights to harvest resource units are clearly defined. (For example, only those who live in the nearby village for more than a year are eligible to fish.)
Proportional equivalence between benefits and costs. Rules specifying the amount of resource products that a user is allocated are related to local conditions and rules requiring labor, materials, and/or money inputs.
Collective-choice arrangements. Many of the individuals affected by harvesting and protection rules are included in the group who can modify these rules.
Monitoring. Monitors, who actively audit biophysical conditions and user behavior, are at least partially accountable to users and/or are users themselves.
Graduated sanctions. Users who violate rules-in-use are likely to receive graduated sanctions (depending on the seriousness and context of the offense) from other users, officials accountable to these users, or both.
Conflict-resolution mechanisms. Users and their officials have rapid access to low-cost, local arenas to resolve conflict among users or between users and officials.
Minimal recognition of rights to organize. The rights of users to devise their own institutions are not challenged by external governmental authorities, and users have long-term tenure rights to the resource.