Part 1:

Suppose that a candy maker owns a building and is renting part of the building's space to a doctor. Further suppose that because the candy maker is the owner, he has the right to make noise during the day while he makes candy. While the doctor cannot insist on a quiet environment, the doctor could move to a quieter building. However, rent in the next best building is $300/month more than rent in the noisy building. The candy maker can adopt a new technology that eliminates the noise for $225/month. Given this situation, can the doctor find a private solution with the candy maker that will make both better off?

Part 2:

What is the minimum and maximum payment the doctor would make to the candy maker to get the doctor to install the noise-reducing equipment? NOTE: Round your answers to the nearest dollar.

Part 1:

Yes, the private solution exists here because of the following:

a) Low-transaction costs due to involvement of only 2 parties,

b) Properly defined ownership rights with regard to building,

c) Benefits received by doctor surpasses the costs borne by the candy maker from noise-free environment.

Part 2:

Minimum payment = 225 dollars and Maximum payment = 300 dollars.

Step-by-step explanation

Part -1:

According to Coase theorem, the private solution ,through bargaining among parties, to an externality problem like noise pollution can guide the market to an efficient outcome even without participation of the government in the form of tax and quota.

For example, there is a factory that pollutes the water of the nearby river (by dumping its waste) and affects the residents living besides this river. In this situation, the factory creates a negative externality and thus, pollutes water excessively. However, if the factory has the right to pollute , and benefits received by residents from cleaner water exceeds the cost borne by the factory from non-polluting the water, then the bargaining between residents and factory can encourage factory owner to reduce polution.

The conditions must for the private solutions are:

a) Low bargaining costs among parties: The parties involved do not have to incur huge transaction cost for bargaining and reaching an agreement.

b) Properly-defined property rights: There should be clarity with regard to ownership of underlying resources.

In the given scenario, there are two parties : doctor and candy-maker which suggests that there would a very low bargaining cost. Similarly, the ownership rights are clearly defined, that is we know that candy maker has the right to make noise. Apart from this, the benefits received by doctor (that is lower rent ) exceeds the costs born by candy maker from noise-free environment ( that is 300 dollars > 225 dollars). Since the both conditions, low transaction costs and well-defined property rights, and benefits outweighing costs are satisfied in the given situation, it implies that there must be a private solution that would make both of the parties better off.

Part -2:

The doctor gets the benefits of $300 from noise-free environment in the form of a lower rent for building and the costs suffered by the candy-maker in the form of new technology is $225. The amount of payment should lie between 225 and 300 dollars for making both parties happy from noise-free environment. So, the minimum amount that the doctor should offer to the owner would be 225 dollars and the maximum payment amount would be 300 dollars.