A Negative Externality Problem

Demand for a good is given by Q = 100 - P. The private marginal cost of production is MCP = 10 + Q. There is a $10 per unit negative production externality in this situation.

-Refer to A Negative Externality Problem.Suppose there are no transactions costs.Also suppose the externality is internalized when the damaged parties offer producers a bribe of $10 per unit to reduce their production.Coasian analysis indicates that social gain in this situation will equal
A) $0
B) $800
C) $1,600
D) $3,200

Question

A Negative Externality Problem

Demand for a good is given by Q = 100 - P. The private marginal cost of production is MCP = 10 + Q. There is a $10 per unit negative production externality in this situation.

-Refer to A Negative Externality Problem.Suppose there are no transactions costs.Also suppose the externality is internalized when the damaged parties offer producers a bribe of $10 per unit to reduce their production.Coasian analysis indicates that social gain in this situation will equal
A) $0
B) $800
C) $1,600
D) $3,200

Quizplus · Accepted Answer

Coasian analysis suggests that the efficient outcome can be achieved by bargaining between the affected parties. In this case, the damaged parties offer a bribe of $10 per unit to producers to reduce their production and internalize the externality. Since there are no transaction costs, the bribe will be accepted and the efficient outcome will be achieved. The total gain to society is equal to the sum of the gains to the producers and the damaged parties. In this case, the gain to producers is $1,200 (120 units x $10 per unit) and the gain to the damaged parties is $400 (40 units x $10 per unit). Therefore, the total social gain is $1,600 ($1,200 + $400).