Consider a pollution problem involving a paper mill located on a river and a com
ID: 1190447 • Letter: C
Question
Consider a pollution problem involving a paper mill located on a river and a commercial salmon fishery operating on the same river. The fishery can operate at one of two locations: upstream (above the mill) or downstream (in the polluted part of the river). Pollution lowers profits for the fishery: without pollution, profits are $300 upstream and $500 downstream; with pollution, profits are $200 upstream and $100 downstream. The mill earns $500 in profit, and the technology exists for it to build a treatment plant at the site that completely eliminates the pollution, but at a cost of $200. There are two possible assignments of property rights: (i) the fishery has the right to a clean river and (ii) the mill has the right to pollute the river.
a. What is the efficient outcome (the maximum of total joint profit)?
b. What are the outcomes under the two different property rights regimes, when there is no possibility of bargaining?
c. How does your answer to (b) change when the two firms can bargain costlessly?
Explanation / Answer
a) According to the coarse theorem, efficient outcome can be reached irrespective of who has the property rights. So both the outcomes are efficient according to coarse theorem.
If fishery has the right to clean water, Profit of fishery = $800
Profit of firm = 500 - 200 = $300
joint profits = $1100
The mill has the right to pollute, profit of fishery = $300
profit of firm = $500
joint profits = $800
Efficient outcome on the basis of total joint profits is if fishery has the right to clean water.
b) This is shown in part (a).
c) If two firms can bargain costlessly,
If fishery has property right, then it is willing to accept payment of atleast $500 for pollution and firms willing to pay upto $200
If firm has property rights, then it will be willing to reduce pollution if it recieves atleast $200 and fishery will be willing to pay upto $500.
If the firm has property rights it would be beneficial for both fishery and firms as efficient bargaining solution can be reached. Bargaining cannot happen in the case where fisheries have property rights.
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