2.

The marginal cost of water pollution on a river is 3Q, where Q measu

res pollution. The marginal

benefit of polluting is 30

-

3Q.

a.

Draw a picture that represents the "market" for water pollution. Calculate and label the

amount of pollution that will occur if there are no regulations on pollution and

negotiation costs are hi

gh.

b.

What is the welfare

-

maximizing amount of pollution? What is the total welfare at that

outcome?

c.

If the producers of pollution own the right to pollute, explain one way that the market

could reach the efficient outcome if negotiation costs are low.

d.

I

f those negatively impacted by pollution own the right to clean water, explain

one way

that

the market could still reach the efficient outcome if negotiation costs are low