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A paper mill, P, produces 10 tons of paper daily when the market price = 80 dollars a ton. For every ton of production, P produces 0.4 tons of pollution. The total cost of production is 5x*x dollars and the private marginal cost of production = 10x dollars (where x is paper output measured in tons). The downstream village of Watertown (WT) spends 15 dollars per ton of water pollution from P to eliminate its environmental harm.
(a) WT wants to bargain with P to reach an optimal agreement on this pollution. Assuming P is still not legally liable for its pollution and both P and WT do not use lawyers, would there be an agreement? How does your answer here relate private efficiency to social efficiency? Fully explain your answer.
(b) Suppose the rule of strict liability is imposed on P. Assuming no transaction costs, how will bargaining proceed?
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