Nick owns a dog whose barking annoys his neighbor Jane. Suppose that the benefit of owning the dog is worth $500 to Nick, and that Jane bears a cost of $700 from the barking. Assume that the city has no ordinance against barking dogs. A possible private solution that would benefit both parties is for:

Question

Quizplus · Accepted Answer

The best private solution in this case is for Jane to pay Nick an amount that compensates him for the benefits he receives from owning the dog, while also compensating Jane for the negative externalities she bears. Since Nick values the dog at $500 and Jane bears a cost of $700, the optimal payment for Jane to make would be somewhere between those two amounts. Choice A, Jane paying Nick $450, does not fully compensate Jane for the cost she bears and may not be sufficient to motivate Nick to give up his dog. Choice B, Nick paying Jane $650, would not incentivize Nick to give up his dog as it doesn't compensate him for the benefits he derives from owning it. Choice C is the optimal solution, as it fully compensates Nick for his gain from owning the dog whilst also fully compensating Jane for her loss caused by the barking. Thus, Jane will pay Nick $650 to get rid of the dog. 
D cannot be the right answer because, as we have seen, there is a private solution that is beneficial for both parties.

Nick Owns a Dog Whose Barking Annoys His Neighbor Jane