Question

The village of Smallville has a river running through it. The 100 residents in Smallville depend on the river for drinking water. A new factory is located upstream of the river and dumps toxins into the river. The factory makes a profit of X a year. As a result of the water pollution, each resident spends Z a year on water purification. If the factory adopts water-purifying technology, it will cost the factory an amount equal to C a year. Assume the toxins will disappear as soon as the factory installs the water-purifying technology. Answer the following questions: a. According to Coase Theorem, how can the residents in Smallville negotiate with the factory if there is no law prohibiting the factory from dumping toxins into the river? Consider the following cases: (1) X > C > 100Z, (2) X > 100Z > C b. How can the residents negotiate with the factory if the residents are entitled by the law to clean drinking water? Consider the following cases: (1) X > C > 100Z, (2) X > 100Z > C, (3) C > 100Z > X

Answer 1

a.
(1) Each resident spends Z on water purification,
As the cost of building water, the purifier is higher than the villagers cleaning it.
(2) Residents pay the factory to install water-purifying technology
This would be effective, as the villagers' small payment in constructing a purifier is less than them cleaning it themselves.
b.
(1) Factory pays each resident to install water purification,
As the factory is discharging, the waste and residents have to clean. This is the correct choice.
(2) Factory adopts water-purifying technology,
This would be more cost-effective in the long run.
(3) Factory shuts down
Profit is less than everything else, which means no other choice other than to shut down.

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