Consider a city with a river. The city has a resort whose visitors use the river

Question

Consider a city with a river. The city has a resort whose visitors use the river for recreational purposes. The city also has a tannery that creates industrial waste which it dumps into the river. This pollutes the river, and makes the river a less desirable vacation location. That is, the tannery's effluent decreases the resort's profits.

Suppose that the tannery can use a production method that includes water recycling. This would reduce the pollution in the river to levels that are safe for recreation, and would no longer affect the resort. When using the recycling method, the tannery's profits are $1,500/week, and the resort's profits are $1,700/week. With the recycling method, the tannery's profits are $2,000/week and the resort's profits are $1,000/week.

Suppose that the resort has the property right to the river. That, the resort has the right to a clean (unpolluted) river. How much would the tannery be willing to pay per week for the right to pollute the river; how much would the resort be willing to allow the tannery to pollute the river for (not using the recycling method), and if the firms can bargain at no cost, which method would the tannery choose?

Explanation / Answer

Use the recycling method, but not pay the resort any money, becuase the total social bebefit of using the recycling method is greater than not using it.

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