the fishery has the right to clean water. Absent any other agreement, it could
demand 100 percent cleanup. However, a quick check of Table 11.1 demon-
strates the mutual advantage of an agreement at 50 percent cleanup. The mill
saves $70,000 in cleanup costs, while the loss to the fishery is only $30,000.
Thus, a payment of, say, $50,000 from mill to fishery in exchange for the right
to 50 percent discharge would be mutually beneficial.
Suppose, instead, that the mill has the right to pollute (i.e., to elect 0 per-
cent cleanup). Now the fishery must pay the mill to reduce its pollution.
Nonetheless, the efficient agreement remains at 50 percent cleanup. A pay-
ment by the fishery of $60,000 (or, more generally, any payment between
$50,000 and $70,000) would be mutually beneficial. No matter where they start,
the parties always have an economic incentive to negotiate their way to an effi-
cient outcome, because this outcome affords the greatest joint gain.
Another solution to the problem is to give the party harmed by the exter-
nality the right to sue for damages. If an externality is produced, the injured
party brings the case to court and will be awarded monetary damages (from the
defendant) equal to the economic cost it suffers. This system of private dam-
ages is exactly analogous to an externality tax. The initiator of the externality
is made to pay the full external cost of his or her actions. The difference is that
the payment is private; it goes to the injured party, not the government. As an
illustration, suppose the fishery holds the right to clean water and can sue for
full damages. The mill has three options: 100 percent cleanup at a cost of
$120,000 and no damages paid; 50 percent cleanup at a cost of $50,000 and
damages of $30,000 (the harm done to the fishery); or 0 percent cleanup and
damages of $100,000. Clearly the mill’s cost-minimizing action is 50 percent
cleanup. This is precisely the efficient outcome.462 Chapter 11 Regulation, Public Goods, and Benefit-Cost AnalysisThe world is faced with an environmental problem of unprecedented com-
plexity. Across the globe, countries contribute to global warming through the
emission of greenhouse gases (GHG)—primarily carbon dioxide (CO 2 ), but
also methane and nitrous oxides. Sources of these gases include fossil-fuel
energy use, industrial and agricultural processes, and forest burning. Surface
temperatures have risen almost 1.5 degrees Fahrenheit over the past century,
and the rate of increase has increased in recent years.
One potential result of warming is a rise in sea levels, implying significant
coastline regression across the globe. A second result is regional climatic
changes (caused chiefly by alterations in global wind patterns and ocean
currents)—less rainfall in the American Midwest and central Canada, more
frequent typhoons in the Indian peninsula, possible alteration of the Gulf
Stream, reduced water levels in the world’s major rivers. A third consequence
(largely unknown) is the effect of a CO 2 -rich atmosphere on agricultural yields
(crop growth, plant diseases, and so on).Global Warmingc11RegulationPublicGoodsandBenefitCostAnalysis.qxd 9/29/11 1:34 PM Page 462