Reference no: EM133081159

A factory is located upstream from the town of Smallville, population 6,000. The factory owners place a value of $5 million on the factory ongoing operations. The factory is leaking dangerous chemicals into the stream. The inhabitants of Smallville get their drinking water from the stream. The chemicals are causing headaches that cause the inhabitants to miss many days of work, resulting in each inhabitant losing an average of $500 in wages each year.

The factory could install filters that reduce the leakage of the dangerous chemical. Installing this filter would cost the factory $ 2 millions a year. Alternatively, the inhabitants could install wells on their property that would not be affected by the factory's chemical leaks. Installing the wells would cost each inhabitant $400 a year.

a) What is the socially efficient configuration of activities - factory installing the filters or residents installing wells? Why? Make sure to provide a numerical explanation by specifying how individual and social payoffs change.

b) Assume that the court protect the residents' right to be free from interference through a property rule. Given the circumstances of the case, what pattern of activity would you have expected to observe? Why? Would Coaseian bargaining likely succeed in allocating the property rights efficiently? (Examine the parties' willingness to pay/accept and examine the structure of transaction costs based on the relevant course concepts discussed in class).

c) Assume that the court protect residents' right to be free from interference through a liability rule, what would be the most likely outcome you have expected to observe? Why? Would Coaseian bargaining likely succeed in allocating property rights efficiently? (Examine the parties' willingness to pay/accept and examine the structure of transaction costs based on the relevant course concepts discussed in class).

d) Assume now that the court assigns the right to pollute the stream of water to the factory and that this right is protected by the court through a property rule. What would be the most likely outcome you have expected to observe? Why? Would Coaseian bargaining likely succeed in allocating property rights efficiently? (Examine the parties' willingness to pay/accept and examine the structure of transaction costs based on the relevant course concepts discussed in class).