Coase. 20 households live around a coal fired power plant. Each suffers damages

Question

Coase. 20 households live around a coal fired power plant. Each suffers
damages equal to $20 as a result of the pollution from the plant. The plant
earns 1 billion dollars in profits each year, and it would cost $394 to install
pollution control. Installing the pollution control equipment would completely
eliminate the damages suffered. For now, assume zero transaction costs or
free-riding.
a) What outcome should occur if the townspeople owns the right to clean air? (The firm has two choices: pay the townspeople, or install pollution control)

b) What outcome will occur if the firm owns the right to pollute? (The towns-people have two options: deal with the pollution or pay the firm to install pollution control.)

c) Suppose the townspeople own the right to clean air, but refuse to negotiate with the plant and forces them to shut down. Explain why this is inefficient.

Explanation / Answer

When the townspeople have the right to have a fresh air they will demand the plant owner to not create pollution. The plant owner will observe that either it can pay $400 as a compensatory amount and will continue to pollute or it can install the pollution controller and this will cause $394. Because installing the controller is less costly it will install the pollution controller.

When the plant owner has the right to pollute it will continue to pollute unless it is paid the amount which is the price of the controller. Town people will be maximum paying $400 as they do not want the damage to the clean air. And this amount is higher than what controller can be purchased. So they will negotiate between a price of $400 and $394. Ultimately the controller will be installed.

If the town people has the right to clean air but they refuse to negotiate it is inefficient because bargaining solution was possible but it was not achieved due to the non negotiation policy of town people. This implies that a better solution could have been achieved which would have been Pareto improvement but was denied.

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