Paul owns a mushroom farm. The smell from the farm reduces the value of adjacent houses by a total of $20 000. Suppose that the benefit of the mushroom farm to Paul is $30 000. Assuming that Paul has the legal right to own the farm, a possible private solution to this problem is that:

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Here we restate the question and list the answer options to frame the analysis.
Question: Paul owns a mushroom farm. The smell from the farm reduces the value of adjacent houses by a total of $20,000. Suppose that the benefit of the mushroom farm to Paul is $30,000. Assuming that Paul has the legal right to own the farm, a possible private solution to this problem is that:
Options:
 a. adjacent property owners pay Paul $20,000 to stop farming mushroom
 b. Paul pays the adjacent property owners $30,000 to compensate them for the loss in house values
 c. there is no private solution that would improve this situation
 d. adjacent property owners pay Paul $25,000 to stop farming mushrooms

Analysis of each option:
Option a: adjacent property owners pay Paul $20,000 to stop farming mushroom.
- This creates a transfer where the owners compensate Paul enough to offset his 30,000 benefit loss if he stops? Not exactly: If Paul stops farming, he loses 30,000; if owners pay 20,000, Paul’s new payoff is 30,000 − 20,000 = 10,000. Owners’ payoff becomes −20,000 + 20,000 = 0. This exchange yields Paul with 10,000 and owners with 0, which is a Pareto improvement over the baseline where owners had −20,000 and Paul had 30,000 combined total welfare of 10,000. Thus this is a feasible private agreement that improves welfare and aligns with Coasean bargaining when rights are with the farm owner.

Option b: Paul pays the adjacent property owners $30,000 to compensate them for the loss in house values.
- If Paul pays 30,000 to the owners to stop farming, Paul’s payoff becomes 30,000 − 30,000 = 0, and owners’ payoff becomes −20,000 + 30,000 = 10,000. While this is also a private transfer leading to the farm stopping (since the owner now has an incentive to accept), it is not the most efficient within the given constraints because it costs Paul his entire private benefit of 30,000 while giving the owners positive value; a smaller payment (e.g., 20,000) already achieves a Pareto improvement and leaves Paul with more than 0. Therefore this option is possible but not the most efficient private solution, and in typical Coase reasoning the exact payment would adjust to maximize both sides’ benefits.

Option c: there is no private solution that would improve this situation.
- This contradicts the Coase theorem intuition here: with transferable rights and no transaction costs, the parties can bargain to reach an agreement that improves welfare (as seen with a 20,000 transfer). Therefore asserting no private solution exists is incorrect given the numbers provided.

Option d: adjacent property owners pay Paul $25,000 to stop farming mushrooms.
- If owners pay 25,000, Paul’s payoff becomes 30,000 − 25,000 = 5,000, and owners’ payoff becomes −20,000 + 25,000 = 5,000. This also represents a welfare-improving arrangement relative to the baseline, but it is less efficient for both sides than the 20,000 payment (which yields Paul 10,000 and owners 0) or the 30,000 payment (which yields Paul 0 and owners 10,000). While it could be a valid private agreement, it is not the most favorable among the plausible private settlements for maximizing total welfare with good distribution for both.

Summary view:
- Option a presents a straightforward, efficient private solution (a 20,000 transfer) that improves both sides relative to the initial situation and aligns with standard Coasean bargaining when the seller has the right to farm. 
- Option b is feasible but not the most efficient, since a smaller or different transfer could also induce stopping and yield a higher combined value for Paul. 
- Option c is incorrect because private bargaining can improve welfare here given transferable rights and no transaction costs.
- Option d is a valid private settlement but less efficient than option a and thus not the optimal private solution among the listed options.

ECX2953 - ECX5953 - S1 2025 ECX2953-ECX5953 Mid-Semester Test - 20%

Paul owns a mushroom farm. The smell from the farm reduces the value of adjacent houses by a total of $20 000. Suppose that the benefit of the mushroom farm to Paul is $30 000. Assuming that Paul has the legal right to own the farm, a possible private solution to this problem is that:

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