Assume a pulp mill located upstream from a river outfitter (a business providing rafting and fishing excursions) produces 10,000 tons of wood pulp each year at a cost of $4 million. The pulp mill emits toxic chemicals that pollute the river. This water pollution harms the river habitat and reduces the stock of fish in the river. Because of the new pulp mill, the river outfitter attracts fewer customers leading to revenue loss of $2 million a year. The pulp mill could install a new filtering device that would decrease water pollution levels so that the outfitter would not be affected by the mill at all. However, installing and running the filter would increase the pulp mill's costs by $1 million per year. Assume that the river outfitter has clean water property rights and the transaction costs to bargaining between the two businesses are small.
- Under the above conditions will the filter be put on? If the filter is put on who will pay the cost? If the filter is not put on who will pay the cost? (the pulp mill and the outfitter)? Explain your answer. What economic theorem is being used to solve this situation?
- Now assume that the same costs apply but the pulp mill has the water property rights. How will the end results differ from the results in part a where the river outfitter has the property rights to clean water?