Question

There are 10 farms along a river. Each uses fertilizer that causes runoff that lowers the profits of a downstream fishery by adding nitrates to the water. The amount of runoff (nitrates that reach the river) per ton of fertilizer used depends on the slope of the land and the proximity of fields to the river. Half of the farms are steeper and closer, so they produce 1 unit of nitrates in the water for every ton of fertilizer. Half are farther and flatter and producer 0.1 units of nitrates in the water for every ton of fertilizer. Suppose that the damage done to the fishery is $4 for every unit of nitrates in the water.

True or False: Because of the externality, the market for fertilizers is not Pareto efficient. Imposing a tax of $4 per ton of fertilizer paid by all farmers would correct this market failure and ensure that the allocation of fertilizers was Pareto efficient.

Answer 1