Moonshine – homemade hard liquor, usually distilled from corn – has a long tradition in the U.S., and many people enjoy making it at home for their own consumption. Suppose that each time someone in Madison starts making moonshine at home, it imposes $1,000 worth of harm on their neighbors due to the fumes. 300 people in Madison are considering becoming moonshine distillers as a hobby, but they vary in how much enjoyment they would get out of it: 100 of them would get a private benefit of $400 each, 100 would get a benefit of $900 each, and 100 would get a benefit of $1,400 each.
(a) What’s the efficient number of people making moonshine at home in Madison? In the absence of any regulation of home distilling, is the number of people making moonshine likely to be the efficient number, higher, or lower? Explain.
(b) Suppose home distilling was regulated as a nuisance, using a damages rule. How much would compensatory damages be, and how many people would choose to make moonshine?
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(c) Suppose that only 50% of home distillers would be detected and successfully sued. How many people would choose to make moonshine if they were only liable for compensatory damages? Explain how punitive damages could be used to correct this problem.
Now suppose that instead of home distilling being treated as a nuisance, it was instead treated as a crime, punishable by a fine of $5,000. Recall that criminal fines have no social cost.
(d) If detection were free – if the city could costlessly catch and punish whatever fraction of home distillers it wanted – what would be the optimal level of detection (what fraction would be caught)? Explain.
(e) Suppose that detection is not free, and the city faces the following options for how much to invest in catching home distillers:
i：Is the “marginal cost of deterrence” positive or negative?
ii：What level of home distilling does each level of detection lead to?
iii. What is the social benefit or social cost of home distilling at each level of detection?
iv. What is the efficient amount of money for the city to spend on detection?