Question

A factory pollutes a lake which is also used by twenty vacation resorts. It would cost

the factory $1,000,000 a year to prevent the pollution. Each resort faces the following

alternatives (remember that there are twenty resorts):

A: Operate as a resort on

an unpolluted lake, making $100,000/year profit.

B: Operate as a resort on a polluted lake, making $40,000/year profit.

C: Operate as a hunting lodge, making $60,000/year profit, whether or not the

lake is polluted

a.

What is the efficient solution? The facto

ry should (pollute/not pollute)? The

resorts should be operated as (resorts/hunting lodges)?

In answering parts b. and c.

, describe first what happens if there is no bargaining

between factory and resort owners, and then whether bargaining will change the

outcome. Explain briefly.

b.

The factory has the right to pollute if it wants to.

c.

Any resort can enjoin the pollution, so the factory can only pollute if it has

permission from all the resorts.

Answer 1

Answer (a)

Factory pollute and resorts get converted to hunting lodges.

Answer (b)

Without bargaining, factory continues to pollute the lake and resorts convert to hunting lodge as operating on polluted or unpolluted lake won't matter.

With bargaining, outcome would remain the same due to the following reasons:

Value to resorts to keep the lake unpolluted is: $40,000 X 20 resorts = $800,000. $800,000 is what the resorts would be willing to pay to factory which doesn't cover the cost of keeping the lake unpolluted.

Answer (c)

Resorts enjoin the pollution so the factory can only pollute if it has permission from all the resorts.

Without bargaining, till the time all resorts enjoin, factory can't pollute , resorts remain resorts.

With bargaining, factory would be willing to offer a sum of amount for permission of pollute the lake, which it may get it or it may not get it. If factory manages to obtain permission from all the resorts, it pollutes the lake and resorts get converted to hinting lodges.