Suppose that a steel mill operates upstream from a soda bottler. The bottler has

Question

Suppose that a steel mill operates upstream from a soda bottler. The bottler has no eect on the steel mills costs but the steel mill does impose an externality on the bottler by making water purication more expensive. Suppose that prices and costs are such that the production possibilities are given by the second through fourth rows of the following table.

(a) Fill in the cells marked with question marks.
(b) What is the dead weight loss due to the externality?

Possibilities Q1 Q2 Profit 1 Profit 2 Total Merge Firms 10 10 250 No Property Rights 20 5 170 30 200 Mill Shut Down 0 15 0 90 90 Property Rights Mill Pays Bottler ? ? ? ? ? Bottler Pays Mill ? ? ? ? ?

Explanation / Answer

(a)

(b) the dead weight loss due to the externality

250 - 200 = 50

Possibilities Q1 Q2 Profit 1 Profit 2 Total Merge Firms 10 10 250 No property rights 20 5 170 30 200 Mill Shut Down 0 15 0 90 90 Property Rights Mill Pays Bottler 10 10 160 90 250 Bottler Pays Mill 10 10 200 50 250

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