Question

Let a farmer receive $30,000 in income if using polluted river water, and $100,000 in income if using unpolluted river water. A steel plant upstream earns $3 million if it can pollute freely, and $2 million if it is forced to control its pollution. Assume that the river downstream from the steel plant serves 20 identical farmers. What would happen if farmers had the right to clean water?

		The steel plant would pay the farmers nothing and pollute
		The steel plant would pay the farmers more than $1 million for the right to pollute.
		The steel plant would pay the farmers more than $1.4 million for the right to pollute.
		The steel plant would control its pollution.

Answer 1

The steel plant would control its pollution

​​​​​​Steel plant can earn $3 million if it is allowed to pollute freely and it can earn $2 million with no pollution. So, it can earn an extra amount of $1 million if pollution is allowed.

Each farmer can earn $100,000 without pollution and $30,000 with pollution. So, each farmer loses $70,000 due to pollution. There are 20 such farmers. So, total loss due to pollution is $1.4 million.

Farmers have the right to clean water.

If firm wants to pollute freely, it has to compensate for the total loss of the farmers which is $1.4 million. The firm won't do that because it can only earn an extra 1 million with pollution. Compensating farmers fully would lead to a loss to the firm.

And the farmers will not accept anything less than their loss due to pollution as compensation.

So, there is no agreement possible between firm and farmers.

Since the farmers have the right to clean water, the firm has to compromise and control its pollution levels.