Question

Assume that you have a factory that produces frozen food and uses water from the river next to you. There is another plant that produces chemical waste and throws it to the river, such waste gets to you when you pull water from the river. Thus, you must pay for a very expensive process of cleaning the water. There are two possibilities to correct this externality: One is to engage into a contract with the other plant, such that they compensate you for how much you invest in cleaning the water. This contract has high transaction costs, that vary a lot and there is uncertainty about whether you can enforce such contract. The other one is for the government to tax them by the amount you need to pay to clean the water. What solution allows for the achievement of the socially optimal outcome?

		The tax.
		The contract.
		Both deliver the same outcome.
		None.

Answer 1

ANSWER :-

Given that

Assume that you have a factory that produces frozen food and uses water from the river next to you.

There is another plant that produces chemical waste and throws it to the river , such waste gets to you when you pull water from the river.

Here we need to find What solution allows for the achievement of the socially optimal outcome

The principal choice is right - The Tax.

This is so in light of the fact that when the legislature forces charge, they charge that plant for contaminating the asset and accept the sum from them as expense. Along these lines the general public gets back clean water with no extra expense.

The agreement isn't socially ideal result since it has a high exchange cost and furthermore its enforceability is unsure.

Along these lines, first choice is the correct answer.

Thank you