A mill and fishery operate on a river. The fishery can operate at one of two locations - upstream or downstream. Pollution lowers the profits of the fishery: without pollution, profits are $300 upstream and $500 downstream. With pollution, profits are $200 upstream and $100 downstream. The mill earns $500 profit. Technology is available for a treatment plant that completely eliminates pollution, but at a cost of $200. There are TWO possible assignments of property rights
1) the fishery has a right to a clean river
2) the mill has a right to pollute the river
a) what is the efficient outcome?
b) what are the outcomes under the two property rights regimes when there is no possibility of bargaining?
c) how does the answer to (b) change if the companies can bargain without cost?
a) At the efficient outcome, the aggregate welfare, or the total profit, is maximized.
If the mill chooses the treatment plant to eliminate pollution, its profit is 500 - 200 = 300. If not, profit = 500.
The fishery will choose downstream if there is no pollution, as the profit (500) is high. Then the total profit = 300 + 500 = 800.
However, once there is pollution, the mill will make 500, while the fishery will choose upstream and earn 200. Then the total profit = ...
Efficient Outcome is encompassed.