Question

In a remote valley, two businesses share a waterway. Tom's Tomato Farm pumps water from a river and uses it to irrigate its fields. The used water eventually flows back into the river, carrying some of the fertilizer that Tom applies to his crops. Up to a certain point, more fertilizer helps increase Tom's harvest. Downstream, Jay's Riverview Campground offers campsites to interested vacationers. Fertilizer contamination of the river creates algae blooms that adversely affect Jay's business. The functions describing the profits of each establishment are pi_T(F) = 64 + 24F - .5F^2 pi_J(F) = 440 - 16F where the subscripts "T" and "J" refer to Tom's and Jays places of business, respectively. "F" represents the amount of fertilizer in the river generated by Tom a. Derive the functions representing (i) the marginal benefit of fertilizer to Tom and (ii) the marginal cost of fertilizer to Jay. Plot them on a graph b. Suppose that the existing law defines property rights that favor recreational users of waterways (e.g., campsites) at the expense of farmers. A campsite can sue a polluting farmer for prohibitive damages if any pollution takes place, unless the affected parties consent to an alternative agreement. Indicate (i) the amount of pollution that takes place in this scenario, and (ii) the profits ofTom and Jay. Assume that Jay has all the bargaining power (i.e., e captures the entire Coasian bargaining surplus). c. There exists a containment process for recapturing irrigation water in underground troughs and cleansing it of any leached fertilizer contaminants. This technology, which can be purchased for a cost of $X, would prevent Tom's operations from polluting the river at all (regardless of his choice of FO. Suppose property rights and bargaining power are defined as in (b). What is the most Tom would be willing to pay to obtain this new process?

Answer 1

16

See explaination for details

Step-by-step explanation:

a. See attachment for the step by step solution

b. (i) As the property rights are well defined, the equilibrium amount of pollution is socially efficient level , where MBT (F) equals the MCT (F). Thus, F = 16.

(ii) The Coasian bargaining wil begin at F = 0. As Jay possess all bargaing power, Tom is expected to pay Jay for every unit of F he employs an equal amount to his full MBT. Thus, Tom pays Jay 285. However both will get profit from F = 16

c. With the new process, Tom will be able to use F = 24 (driving the marginal benefit of fertilizer to zero) and would not have to pay Jay anything for the right to do so. This is because, solving the profit function will yield 352. Without the technology Tom will earn 67 Therefore he willing to pay upto 285 for this technology.