Question

Suppose that a paper mill earns $700,000 when it pollutes a river, and that it can abate pollution at a cost of $140,000. The effects of pollution are confined to a single farmer, who earns $530,000 if the water is clean and $230,000 if it is polluted. Assume that bargaining is frictionless and that the parties will split the gains from any agreement equally.

a. What agreement will the mill and the farmer negotiate if the mill has the right to pollute?

A. The farmer will pay the mill $220,000.

B. The farmer will pay the mill $140,000.

C. The mill will pay the farmer $220,000.

D. The mill will pay the farmer $140,000.

E. No agreement needs to be made.

Answer 1

Ans - B)The farmer will pay the mill $140,000

Explanation:

The paper mill can abate pollution at cost of $140,000.

So, it will need at least $140,000 to stop polluting the river

If there is no pollution can increase the earning of farmer by $300,000 ( 530000-230000)

if the mill has the right to pollute then it would be beneficial for the farmer to give $140,000 to the mill to stop it from polluting the river as it will bring a gain of $160,000 ( 300000-140000) to the farmer.

So,

Ans - B)The farmer will pay the mill $140,000