Question

A beekeeper is a price taker in the market for honey. At the profit-maximizing output level, the beekeeper earns \(\$ 20\) in revenue per day, but has costs of \(\$ 30\) per day- not enough to stay in business. It turns out, however, that the bees can create a positive externality by pollenating a neighboring farmer's crops-if the beekeeper positions the hives near the farmer's field. The pollination would provide benefits of \(\$ 15\) per day for the farmer. a. Is it economically efficient for the beekeeper to keep operating? Why or why not? b. If the beekeeper has the legal right to charge the farmer for "pollination services," would we expect the farmer and beekeeper-without government intervention-to arrive at the efficient outcome? Explain briefly. [Hint: The Coase theorem applies.] c. If the farmer has the legal right to enjoy "pollination services" without paying, would we still expect the farmer and beekeeper-without government intervention - to arrive at the efficient outcome? Explain briefly.

Short answer

Yes, it is economically efficient for the beekeeper to keep operating because the total social benefits exceed the costs (\$35 vs \$30). Under the Coase theorem, if either the beekeeper or the farmer has legal rights and they negotiate without government intervention, they will likely reach a mutually beneficial deal, and their operation will remain economically efficient.

Step-by-step solution

Calculate Total Revenues and Costs

Firstly, calculate the total revenues and costs. The beekeeper’s revenue per day is \$20 and the cost is \$30. Therefore, the beekeeper is making a loss of \$10 per day.

Evaluate the Economic Efficiency of Beekeeping Activity

An economic activity is considered efficient if the total social benefit is greater than or equal to the total social cost. The beekeeper’s operation generates \$15 in positive externalities per day to the farmer, by providing pollination for the crops. Adding this amount to the beekeeper’s daily earnings gives a total social benefit of \$35 (since \$20 + \$15 = \$35). Given a social cost of \$30, which equals the beekeeper's daily costs, the activity seems economically efficient. This is because the total social benefits (\$35) exceed the social costs (\$30).

Apply the Coase Theorem – Beekeeper's Right

If the beekeeper has the legal right to charge the farmer for pollination services and they both act rationally without government intervention, they could negotiate a price for the service. Following the Coase Theorem, they will reach an agreement, under which the beekeeper charges between \$10 and \$15. If a deal is reached within this range, both the farmer and the beekeeper would be better off and the operation would remain economically efficient.

Apply the Coase Theorem – Farmer's Right

If the farmer has the right to enjoy pollination services without paying, and they both act rationally without government intervention, the farmer could offer the beekeeper a payment to keep the operation ongoing and get pollination services. According to the Coase theorem, the farmer and the beekeeper would negotiate a mutually beneficial payment, between \$10 and \$15. Thus, even in this case, the operation would still be economically efficient.

Key concepts

Positive Externalities

Positive externalities occur when a person's or company's actions have a beneficial effect on third parties who are not involved in the activity. An excellent instance of such an externality can be found in the case of the beekeeper, whose bees provide pollination services to a neighboring farmer's crops. This extra benefit is not reflected in the market transactions between the beekeeper and their customers since it's the farmer who gains an additional advantage.

However, these positive spillover effects are a form of market failure because the beekeeper does not receive compensation for the full value their bees create. When positive externalities exist, the producer may not produce enough of the good or service since they are not earning all the benefits, which can lead to inefficiency in the market. It's important to consider these external benefits when evaluating the economic efficiency of an activity, as they can often justify the continuation of a seemingly unprofitable operation.

Coase Theorem

The Coase theorem, named after economist Ronald Coase, asserts that if property rights are clearly defined and transaction costs are negligible, involved parties will negotiate their own private bargains that will lead to efficient outcomes, irrespective of the initial allocation of rights. This theorem plays a central role in the scenario involving the beekeeper and the farmer.

When the beekeeper has the right to charge for pollination services, the two can negotiate a price that reflects the value of the externalities, leading to an arrangement that benefits both parties. Similarly, if the farmer has the right to enjoy free pollination services, they might still have an economic incentive to support the beekeeper to ensure the continuation of these services. This ability to negotiate and reach a mutually beneficial agreement demonstrates the power of private solutions in addressing externalities, as predicted by the Coase theorem.

Social Costs and Benefits

When analyzing an economic activity, it is imperative to look beyond just private costs and benefits to include social costs and benefits. Social costs include not only the costs incurred by the producer but also costs suffered by third parties due to negative externalities. Social benefits, on the other hand, encompass both private benefits and any positive externalities generated by the activity.

In the provided exercise, the beekeeper's costs of operation are outweighed by the combination of revenue from honey sales and the external benefits to the farmer. These external benefits are crucial as they may tip the scales in favor of preserving an activity that may otherwise seem unprofitable. Through this lens, looking at the beekeeping activity, the total social benefits are greater than the total social costs, indicating that maintaining the beekeeping operation is economically efficient.