Question

Suppose two firms are located by the river. The first produces steel. The second, further downstream, is a resort hotel. The hotel uses the river to attract people to its water sports (a victim of pollution). The steel mill uses the river to dispose of waste (a creator of pollution). If the two facilities have different owners, an efficient use of water is not a likely result. Use a graph to explain how an efficient outcome can emerge if the resort owns the rights to the environment and the steel company approaches the resort to negotiate a payment, from the steel company to the resort. Fully explain the graph.

Answer 1

Production of steel create negative externality for resort hotel and if resort hotel has a property right the first firm cannot dispose the waste and produce steel unless they compensate the loss of hotel resort and hotel resort will allow the production of steel and disposal of waste if compensation provided by steel producing firm is greater than the loss incurred (negative externality) by the disposable of waste and steel manufacture firm will give compensation until compensation is less than than the profit sacrificed by not producing steel

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