Question

Bob, Jack and Norman are the only people living on an island. They are trying to decide whether or not they should build a lighthouse. Bob is willing to pay $1000 for one lighthouse, Jack is willing to pay $1200 for one lighthouse, and Norman is willing to pay $500 for one lighthouse. The cost of providing a lighthouse is $2000. If the lighthouse is a public good, efficiency requires:

Answer 1

Answer:

Efficiency requires that one lighthouse is built since the willingness to pay of all the residents together is larger than the cost of providing the lighthouse

Explanation:

Since the lighthouse is a public good, according to the coase theorem, if the combined willingness to pay for the lighthouse of all of the people living on the islands is higher than the cost of the lighthouse, then a lighthouse should be built.

The total willingness to pay is:

$W = \ 1000+\ 1200+\ 500 = \ 2700$

The population willingness to pay is higher than the cost of building one lighthouse ($2000) but lower than the cost of building two lighthouses ($4000). Therefore, efficiency requires that one lighthouse is built since the willingness to pay of all the residents together is larger than the cost of providing the lighthouse.