A firm's private Marginal Cost is MC(q) = 8q, where qis the level of output. It can sell any number of units of output at the world price of 64. However, production inflicts damage on the firm's neighbours. The Marginal Cost of externality inflicted depends on the firm's output: MC^ext= 4 + 2q.

1. Assume that the neighbours have the property rights, so they can impose legal punitive damages if the firm pollutes at all. In the absence of an agreement between the firm and its neighbours, what would the level of output be? If an agreement maximizing utilitarian welfare between the firm and its neighbours is negotiated, what are the smallest and largest payments that the firm would have to pay?

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