Paying Compensation

Q1

Firstly, I believe that the government should not be allowed to build the prison without paying compensation or buying the right. Considering the utility curves for citizens and government, the loss in property values will cause large drop in the utility of citizens while the set-up of prison will not cause much utility increase for the government. If there is no compensation or any money exchange for the right, then the overall social welfare will be reduced. Therefore, it is clear that the government should do something for citizens. Moreover, if the government is allowed to build the prison without paying anything to property owners, they will have less incentive to run the prison efficiently. Paying compensation or buying rights can intrigue the government to make profits and benefits to offset the money paid to property owners.

Then, for the choices of paying compensation and buying its right, they are the representatives of damage and injunction. It is known that when transaction cost is high, it is better to use the damage rather than injunction (hold-out problem). In our case, if the government wants to buy the right, it needs to get the approval from all citizens who own properties at the neighborhood. Usually there can be many property owners as the prison takes up a large area. Hence, there will be a large transaction cost in order to make every owner satisfied about the monetary exchange for the right to build the prison. For instance, image there are 50 owners, the 49 owners have agreed to sell the right, then the last owner can ask for really high price which the government might agree with in order to buy the right.  However, if the government has the incentive to do so, the rest of owners will anticipate the situation and ask for higher price at the beginning. Then the process will involve a high cost.  In such scenario, it is definitely better for the government to pay the compensation after the built-up of the prison.