A factory benefits from discharging effluent, q, into a lake. The marginal benefit function is given by 60-2q. The pollution causes damages to two nearby communities. The marginal damages to Community A are 1q. The marginal damages to community B are 2q.

a. What is one reason that the damages may be different across the two communities? b. The factory enjoys the natural allocation. What is the level of pollution if the

communities cannot monitor how much the factory pollutes?

What is the total welfare (i.e., total surplus) at this outcome? (Hint: total benefits of pollution to factory minus total costs of pollution to the communities.)

d. What is the optimal level of pollution? What is the optimal level of pollution abatement?

e. What is the total welfare (i.e., total surplus) under this optimal outcome? f. Now suppose a new technology allows the communities to measure the quantity of

pollution from the factory. What is the quantity of abatement that would be observed if the two communities could not reach an informal agreement among themselves, but each community could undertake a transaction with the factory? Would there be a free rider problem, yes or no? If yes, which party would free ride?

g. Now, two other factories start producing in the area and benefit from polluting, too. For each, the marginal benefit from pollution is given by 60-4q. What is the new socially optimal quantity of pollution?