Life on Dismal Lake
Act I
The Smith family owns all the land around 100-acre Dismal Lake and builds its home on the eastern edge of the lake. Life is very pleasant for the first year. Then, unknown to Mama and Papa, the Smith children begin throwing the family garbage in the lake when they take it out once a week, because this is easier than carrying the bags all the way to the road for the country trash trucks to pick up. After a few months the lake begins to stink, and Mama and Papa Smith discover where the garbage has been going. The Smith children are now dismal because they must clean up the lake instead of going out with their friends for the next four weekends.
Questions for discussion
Only the Smith family lives on the lake. Is there an externality problem (i.e. are any costs imposed on others outside the family when the children throw the trash in the lake?) How should this problem be solved?
Act II
When the Smith children go to college, Mama and Papa Smith sell all the land around Dismal Lake except their one-acre homestead to a man named Snidely Whiplash. Whiplash builds a home on the western edge of the lake and immediately starts throwing garbage into the lake instead of taking it out to the road for the country trash service.
Questions for discussion
Now both the Smiths and Whiplash live on the lake. Is there an externality problem when Whiplash throws garbage into the lake? How should this problem be solved?
Act III
One year later Whiplash, who turns out to be an unscrupulous land developer, stops throwing trash in Dismal Lake and cleans it up. Then he subdivides the land, sells homestead plots to 15 families for $100,000 each and moves away. The 15 new owners build large houses on their lots. After a few months, garbage shows up on and around Dismal Lake again – this time from two or more unidentified families. The Smiths call a neighborhood meeting to discuss the problem. At the meeting, four families accuse five other families of throwing garbage in the lake. The accused families deny the charges and accuse other families. The meeting breaks up with everyone shouting at each other. Dismal Lake continues to be a smelly, dismal place.
Questions for discussion
Now 16 families live on the lake. Is there an externality problem when some unidentified families throw garbage into the lake? How can this problem be solved?