Question: An underground aquifer in a developing country is available to all farms in a small community. Assume that it costs 50 pesos per day to operate a pump that can extract groundwater from the aquifer. The value that a farm can obtain by using or selling the water depends on how many farms extract water, as given in the table below
Number of farms Revenue per day per farm Profit per day per farm Total profit
extracting water (pesos) (pesos) (pesos)
1 100
2 100
3 100
4 90
5 80
6 65
7 55
8 40
9 20
a. Assuming that there is no regulation of the aquifer, how many farms will exact ground water? Assume that as long as each farm is making a profit, there is an incentive for more farms to extract water. Fill in the third column of the table to help you answer this question.
b. Is this unregulated outcome economically efficient? Explain.
c. What would be the economically efficient level of groundwater extraction (number of farms extracting water)? Hint: calculate total profit by multiplying number of farms by profit per farm and see where total profit reaches a maximum. At this point, the extra profit made by adding one more farm is just balanced by the losses to other farms.