Consider a competitive firm engaging in risky activity, where damage is a function of output level x. The cost of production is C(x), which is increasing and convex in x. The damage function is D(x) and the cost of care is simply a, as before.

(a) Determine the socially optimal levels of output and care.

(b) Determine a competitive and solvent firm’s choice of output and level of care under both the strict liability and the negligence rule for an arbitrary due care level ā.

(c) Assume now that the firm may become non-solvent in case of an accident. Determine the competitive firm’s choice of output and level of care under both the strict liability and the negligence rule, for an arbitrary due care level ā.