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 microbrewery has the right to clean water.What would the Coase Theorem suggest as the resolution of this negative externality conflict between these two firms?
A) The microbrewery pays $200 to the chemical factory to filter its waste before dumping it into the river.
B) The chemical factory voluntarily filters its waste before dumping it into the river.
C) The chemical factory pays $200 to the microbrewery to get permission to dump into the river.
D) The chemical factory pays $300 to the microbrewery to get permission to dump into the river.

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 microbrewery has the right to clean water.What would the Coase Theorem suggest as the resolution of this negative externality conflict between these two firms?
A) The microbrewery pays $200 to the chemical factory to filter its waste before dumping it into the river. 
B) The chemical factory voluntarily filters its waste before dumping it into the river. 
C) The chemical factory pays $200 to the microbrewery to get permission to dump into the river. 
D) The chemical factory pays $300 to the microbrewery to get permission to dump into the river.

Quizplus · Accepted Answer

The Coase Theorem suggests that if the transaction costs are low and property rights are well-defined, then the two parties can negotiate and reach an efficient outcome without government intervention. In this scenario, the microbrewery has the right to clean water, which means that the chemical factory needs to negotiate with the microbrewery to pollute the water or find a way to filter its waste before dumping it into the river. Since the cost of filtering the waste is high for the chemical factory, it can negotiate with the microbrewery to allow it to dump the waste for a fee. Therefore, the most efficient outcome would be for the chemical factory to voluntarily filter its waste before dumping it into the river.

Scenario: a Chemical Factory Is Located Upstream on a River