Question

Ingvar and Olaf are the only two fishermen in their area. Each has been assigned an ITQ that allows him to catch 20 tons of salmon. Ingvar's MC of catching salmon is \(\$ 6\) per ton while Olaf's MC of catching salmon is \(\$ 7\) per ton. If the price of salmon is \(\$ 10\) per ton, then to maximize efficiency, the two guys should trade ITQs until Ingvar is in charge of catching_____, tons while Olaf catches________ tons. a. \(20 ; 20\) b. \(30 ; 10\) c. \(40 ; 0\) d. \(0 ; 40\)

Short answer

Ingvar should catch 40 tons, Olaf should catch 0 tons (option c).

Step-by-step solution

Understand the Problem

We need to determine how many tons of salmon each fisherman should catch to maximize efficiency through trading Individual Transferable Quotas (ITQs). Since the price of salmon is $10 per ton, both fishermen will aim to catch salmon when their Marginal Cost (MC) of catching it is less than the price.

Calculate Ingvar's Profitability

For Ingvar, who has an MC of $6 per ton, the profit per ton is $10 - $6 = $4. Since the profit is positive, Ingvar will aim to catch as much salmon as possible.

Calculate Olaf's Profitability

For Olaf, who has an MC of $7 per ton, the profit per ton is $10 - $7 = $3. Since the profit is also positive, Olaf is willing to catch salmon, but Ingvar has a higher profit margin per ton.

Trading ITQs for Efficiency

To maximize overall profitability, ITQs should be traded such that the cheaper option is fully utilized first. Since Ingvar's MC is lower, it is efficient for him to catch as much salmon as possible up to his maximum capability of 40 tons. Hence, Olaf should transfer his ITQ to Ingvar.

Determine Tons Caught by Each Fisherman

Since Ingvar can catch a maximum of 40 tons and Olaf catches none when ITQs are traded, the efficient allocation is for Ingvar to catch 40 tons and Olaf to catch 0 tons.

Key concepts

Marginal Cost

Marginal cost is a critical concept in understanding how to operate efficiently in any production environment, including fishing with Individual Transferable Quotas (ITQs). Marginal cost, in simple terms, is the additional cost of producing one more unit of a good or service. In our fishing scenario, it represents how much it costs Ingvar and Olaf to catch one more ton of salmon.

• For Ingvar, the marginal cost is $6 per ton.
• For Olaf, it's slightly higher at $7 per ton.

This means each additional ton Ingvar catches costs him $1 less than it costs Olaf. Understanding these costs is crucial because both fishermen want to maximize their profits by catching salmon if their marginal cost is lower than the current selling price of $10 per ton.

Profitability Analysis

Profitability analysis involves looking at the difference between selling price and cost to determine how much profit can be made. In our example, if the price of salmon is $10, we can calculate the profit per ton for both Ingvar and Olaf.

• For Ingvar, the profit is $10 minus his marginal cost of $6, resulting in a profit of $4 per ton.
• For Olaf, it is $10 minus $7, which equals $3 per ton.

From this analysis, we can see that Ingvar has a higher profit per ton, indicating he is currently better positioned to catch more salmon under the current price conditions and ITQ structure. Ingvar stands to make more profit, so it makes sense for him to take on more of the catch than Olaf.

Resource Allocation

Resource allocation is a vital strategic decision in maximizing Resource allocation is about deciding the best way to use limited resources to achieve the maximum benefit. In the context of ITQs and fishing, this means assigning the quota to the fisherman who can catch salmon more cost-effectively. Separating quotas between Ingvar and Olaf initially may not be the best strategy since Ingvar can catch fish at a lower cost.

• For maximum profitability, we reallocate, allowing Ingvar with $6 MC to catch more than his initial 20-ton quota.
• Olaf, with the $7 MC, will transfer his quota to Ingvar as Ingvar can make more profit from it.

Therefore, reallocating the quotas efficiently means Ingvar should utilize both his and Olaf's quota to maximize potential profit and ensure better economic outcomes for both.

Economic Efficiency

Economic efficiency occurs when resources are used in a way that maximizes the production of goods and services. It means getting the best outcomes with the least waste of resources. In this fishing scenario, we achieve economic efficiency by ensuring the total catch is handled by the fisherman with the lower marginal cost.

• Efficiency is gained because Ingvar catches salmon at a lower cost and thus, Olive's quota is better utilized by Ingvar.
• By transferring Olaf's ITQs to Ingvar, the overall cost of production (catching salmon) decreases, while output remains the same.

This efficient resource allocation allows both fishermen to potentially benefit financially, as one maximizes profit while the other avoids higher costs. This transfer leads to Ingvar catching all 40 tons, which optimizes their joint income from the activity.