An airport is located next to a large tract of land owned by a housing developer. The developer would like to build houses on this land, but noise from the airport reduces the value of the land. The more planes that fly, the lower is the amount of profits that the developer makes. Let X be the number of planes that fly per day and let Y be the number of houses that the developer builds. The airport’s total profits are 48X−X2, and the developer’s total profits are 60Y − Y2 − XY. Let us consider the outcome under various assumptions about institutional rules and about bargaining between the airport and the developer.
(a) “Free to Choose with No Bargaining”: Suppose that no bargains can be struck between the airport and the developer and that each can decide on its own level of activity. No matter how many houses the developer builds, the number of planes per day that maximizes profits for the airport is ___________ Given that the airport is landing this number of planes, the number of houses that maximizes the developer’s profits is ___________ Total profits of the airport will be ____________ and total profits of the developer will be _________ The sum of their profits will be ____________
(b) “Strict Prohibition”: Suppose that a local ordinance makes it illegal to land planes at the airport because they impose an externality on the developer. Then no planes will fly. The developer will build ___________ houses and will have total profits of __________
(c) “Lawyer’s Paradise”: Suppose that a law is passed that makes the airport liable for all damages to the developer’s property values. Since the developer’s profits are 60Y − Y2 − XY and his profits would be 60Y − Y2 if no planes were flown, the total amount of damages awarded to the developer will be XY. Therefore if the airport flies X planes and the developer builds Y houses, then the airport’s profits after it has paid damages will be 48X − X2 − XY . The developer’s profits including the amount he receives in payment of damages will be 60Y − Y2 − XY + XY = 60Y −Y2. To maximize his net profits, the developer will choose to build ____________ houses no matter how many planes are flown. To maximize its profits, net of damages, the airport will choose to land ___________ planes. Total profits of the developer will be ____________ and total profits of the airport will be _________. The sum of their profits will be __________