Suppose a paper mill is located by a river. Its production process generates pol

Question

Suppose a paper mill is located by a river. Its production process generates pollution that can be dumped into the river at no cost, generating profits of 400. Or it could install filters to control its emissions at a cost of 300, leaving a net profit of 100. A fishery is about to locate by the same river, and it needs to decide whether to locate upstream or downstream from the paper mill. If it locates upstream, it earns profits of 300 when the paper mill does not abate pollution and 500 when the paper mill does abate pollution. If it locates downstream, it earns profits of 200 when the paper mill does not abate pollution and 700 when the paper mill does abate pollution.

A. Suppose that the paper mill has the right to pollute, and the right is enforced with a property rule. What is the fishery’s willingness to pay to induce the paper mill to stop polluting? Why?

B. Suppose that the paper mill has the right to pollute, and the right is enforced with a property rule. What is the paper mill’s willingness to accept in order to stop its pollution? Why?

C. Consider the willingness to pay on the part of the fishery and the willingness to accept on the part of the paper mill in Questions a and b. Suppose that there are no transaction costs for bargaining. Will the parties bargain? Why? Identify which action each party will take, and whether the outcome is efficient.

Explanation / Answer

a).

Suppose the property right is assigned to the “paper mile”, => “paper mile” have the right to pollute into the river. So, if the “fisher man” is about locate upstream, => the fisher man will pay maximum “500-300=200” to induce the paper mill to stop pollution. Now, if the “fisher man” is about locate downstream, => the fisher man will pay maximum “700-200=500” to induce the paper mill to stop pollution.

b).

now, if the “paper mill” control emission, then profit reduce to “100” from “400”, => minimum the “paper mill” owner will accept “400-100=300” to control the pollution.

c).

So, here we can see that if the property right is assigned to the “paper mill owner”, => the “fishery” will want to pay maximum “500” if located to “downstream” and the “paper mill owner” will want to accept minimum “300”, => as the fisher man’s will ness pay is more than the “mill owner’s” will ness to accept, => here there will be bargaining between two party.

Now, here as a rational person fisher man will not locate to “upstream” and will pay to control the pollution to increase its profit. So, here the outcome will between “300” to “500” and the outcome will be efficient.

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