23

1. Suppose a steel plant that refines iron ore into steel generates and dumps significant amounts of mercury into a local river. Further suppose a farmer earns money by selling tomatoes which they irrigate using water taken from the local river. The mercury greatly reduces the yield for the tomato farmer. Below is the Marginal Benefit function for the steel plant and the Marginal Damage function for the farmer. Use them to answer the following questions.

MBs =1,000Q

MDf =Q

A) Assume that the steel plant has the property right for the river, meaning they can dump however much mercury into it as they want. Find the total benefit to the plant and total damage to the farmer from this scenario if there is no bargaining.

B) Revisit part I again, but now assume the steel plant is willing to bargain with the farmer. What is the optimal production of steel (Q) in terms of social welfare (benefits - damages)? What is the minimum compensation the steel plant would accept to produce at the optimal level?

C) Now assume that the farmer has the property right. Does the optimal solution change? What is the minimum compensation the farmer would accept to allow the steel plant to produce at the optimal level?