Question

A chemical factory is located upstream on a river. The factory dumps its liquid waste into the river. A microbrewery is located downstream on this​ river; it uses the river water in its production process and values the clean water. The chemical factory can filter its liquid waste before dumping it into the​ river, but it would be costly to the factory. The table shows the profit to these two businesses under different circumstances.

	Profit with Filtering	Profit without Filtering
Chemical factory	​$800	​$1,000
Microbrewery	​$400	​$100

Could this externality problem be resolved by private negotiations between the chemical factory and the​ microbrewery?

A.

​No, because dumping the waste into the river is free for the chemical factory.

B.

​No, because filtering the waste decreases the profit of the chemical factory.

C.

​Yes, but only when the negotiations are relatively costless.

D.

​Yes, but the chemical factory should be forced to pay a fine for polluting the river.

Answer 1

Correct Answer:

C

The bargaining process between the two entities can be successful as per the Coase theorem, but it has a condition that cost of transaction or negotiation should be least or costless.