A competitive firm pollutes the air. The following graph shows the demand for the firm€™s product and the private and social marginal cost curves. The numbers in the graph represent areas.

a. Suppose there are no transaction costs, that there is no legal penalty for polluting, and that it is impossible for the neighbors to move. What quantity does the firm produce? Give a concrete description of a deal that might be struck between the firm and the neighbors (including the exact amount of money that changes hands). What is the social gain from this transaction? (Your answer should be a number.)
b. Suppose transaction costs are so high that negotiation is impossible, and that it would cost the neighbors $6 to move. Under each of the following scenarios, determine whether or not the neighbors move, determine how much the firm produces, and compute the social gain. Which policy or policies are most efficient?
Policy I: The firm faces no penalty for pollution.
Policy II: The firm pays an excise tax equal to the amount of the externality it causes; all tax revenue is paid to people who live 3,000 miles away.
Policy III: The firm must reimburse the neighbors for all pollution damage.
c. Repeat part (b) on the assumption that it costs the neighbors $15 (instead of $6) tomove.

Transcribed Image Text:

Price MCsoddl Demand 8 12 Quantity 70 80