A paper mill, P, competes in a perfectly competitive international market. P produces 10 tons of paper daily. The market price = $100 a ton. For every ton of production, P produces 0.5 tons of pollution. The private cost of production is $5x2 and the private marginal cost of production = $10x (where x is paper output of P measured in tons). The downstream village of Watertown (WT) spends $20 per ton of water to eliminate the pollution from P.

  WT wants to bargain with P to reach an optimal agreement on this pollution. Assuming P is still not legally liable for its pollution and both P and WT do not use lawyers, would there be an agreement? How does your answer here relate private efficiency to social efficiency? Fully explain your answer. 

Considering your answers in parts (a) and (b), how high can transaction costs become before bargaining is prevented? In your answer, explain what happens if P and WT are required to have their own lawyers?

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In a perfectly competitive international market a paper mill P produces 10 tons of paper daily The market price of paper is 100 per ton However for ev... View the full answer