Scenario: A chemical factory is located upstream on a river. The factory dumps its liquid waste into the river. A microbrewery is located downstream on this river; it uses the river water in its production process and values the clean water. The chemical factory can filter its liquid waste before dumping it into the river, but it would be costly to the factory. The table below shows the profit to these two businesses under different circumstances.

-Refer to scenario above.Suppose the negotiation between the chemical factory and microbrewery is costless.What is the maximum that the microbrewer would be willing to pay the chemical factory to filter its waste?
A) $100
B) $200
C) $300
D) $400

Question

Scenario: A chemical factory is located upstream on a river. The factory dumps its liquid waste into the river. A microbrewery is located downstream on this river; it uses the river water in its production process and values the clean water. The chemical factory can filter its liquid waste before dumping it into the river, but it would be costly to the factory. The table below shows the profit to these two businesses under different circumstances.
 
-Refer to scenario above.Suppose the negotiation between the chemical factory and microbrewery is costless.What is the maximum that the microbrewer would be willing to pay the chemical factory to filter its waste?
A) $100 
B) $200 
C) $300 
D) $400

Quizplus · Accepted Answer

The microbrewery values clean water at $500 and would lose $200 in profit if the water became polluted (Scenario 3). Therefore, they would be willing to pay up to $200 to prevent this loss. The chemical factory incurs an additional cost of $100 to filter its waste, but this would result in increased profits of $300 (Scenario 2). Therefore, if the microbrewery were to offer the chemical factory up to $300, both parties could benefit from the arrangement. Anything less than $300 would not be enough for the chemical factory to incur the cost of filtering its waste, and anything more than $300 would not be worth it for the microbrewery to pay given their potential loss of $200 in profit.

Scenario: a Chemical Factory Is Located Upstream on a River