Negotiating an Externality
A chemical plant is located upstream from a large farm. The plant's production process releases a byproduct into the river, which reduces the farm's annual profits. The table below shows the plant's profits and the farm's losses at different levels of chemical output. Assume that transaction costs for negotiation are zero and that the plant currently has the legal right to produce at any level it chooses, leading it to maximize its own profit.
| Chemical Output (tons) | Plant's Annual Profit | Farm's Annual Loss from Pollution |
|---|---|---|
| 0 | $0 | $0 |
| 1 | $100,000 | $30,000 |
| 2 | $180,000 | $70,000 |
| 3 | $240,000 | $120,000 |
| 4 | $280,000 | $180,000 |
Analyze the data to determine the range of annual payments the farm could offer the plant to persuade it to reduce its output from 4 tons to 3 tons, such that the agreement is beneficial for both parties.
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