Question

Assume there is a badly polluting steel plant in town. Marginal pollution cost is growing and given by MC=10X where X stands for the quantity of pollution and is measured in percent (0% pristinely clean, 100% deadly pollution). In contrast, marginal reduction cost (MCR) is constant and given by MCR=10. Refer to the Coase Theorem and assume that the government grants citizens the exclusive property right to clean air. After trade, what is the "optimal" air pollution (in %)? What is the resulting welfare gain or loss compared to the initial pristine air scenario (before trade).

- the optimal pollution equals 5, and there is a welfare gain of 5

- the optimal pollution equals 10, and there is a welfare loss of 5

- none of the listed options

- the optimal pollution equals 1, and there is a welfare gain of 5

- the optimal pollution equals 1, and there is a welfare loss of 5 ]

- there is no optimal pollution, the optimal pollution. is always zero

Answer 1

Coase Theorum states that whenever there are conflicting property rights, bargaining between the parties would be involved which would lead to an efficient outcome considering the transaction costs are minimal. The welfare of the people is taken into account at utmost importance.

Given- Marginal Pollution Cost MC= 10X

Marginal Reduction Cost= 10 (constant)

ANSWER-  The optimal pollution air quality would be Optimal Air quality= 1 and Welfare Gain= 5. This is a desired answer simply because it minimizes the transaction costs and provides the public with maximum gain.

The rest of the options would not suffice because either they are mentioning a direct welfare loss to the public, something that would be highly undesirable and wouln't work in the case of Coase Theorum when the property rights are with the public, or the transaction costs are extremely high, again a solution that wouldn't be feasable.