Two farms are located next to each other. During storms, sewage from Farm 1 flows into a stream located on Farm 2. Farm 2 relies on this stream as a source of drinking water for its livestock, and when the stream is polluted with sewage, the livestock become sick and die. The annual damage to Farm 2 from this form of pollution is $100,000 per year. It is possible that Farm 1 can prevent the runoff of sewage by installing storm drains. The cost of the storm drains is $200,000.
a) Provide an argument that the Coase Theorem holds in this situation.
b) Suppose that the damage to Farm 2 is $500,000 per year, not $100,000 per year (with the cost of storm drains remaining fixed at $200,000). Provide an argument that the Coase Theorem holds in this case.
This question was answered on: Jul 11, 2017
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