Suppose that property rights to environment are establish

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A Short Example of Externalities (Coase Theorem)

Jack and May are the only residents of a small island. Jack operates a papermill, and has costs given by MPC = 10+2Q. Jack gets a price of $24 for each unit of paper he sells. May hates the pollution that the mill produces, and has damages given by MEC = Q + 2.

(a) Assume that property rights to the environment are established, and Jack has them. Further, assume that Jack and May can engage in costless bargaining. What will Jack's production level Q_ be in equilibrium?

(b) What is the minimum amount May would have to pay for Jack to produce at Q_? What is the maximum amount May would be willing to pay for Jack to produce at Q_.

(c) If May had the property rights, what is the minimum payment Jack would have to make to produce at Q_? What is the most he would be willing to pay?

Reference no: EM1339271

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