Discussion
Consider a case of negative production externality, where \(MSC\) is marginal social cost, \(MPC\) is marginal private cost, and \(MPB\) is marginal private benefit. Assume that the property rights belong to the polluter. As per the Coase theorem, payment \((p)\) will be acceptable to both parties (i.e., polluter and the affected party) when
Answer: A
A payment is acceptable to both when \((MSC - MPC) \gt p \gt (MPB - MPC)\).
With property rights resting with the polluter, the affected party must pay the polluter to cut output by a unit. The polluter accepts only if the payment covers what it gives up on that unit, its net private gain \(MPB - MPC\). The affected party pays only if the payment is less than the damage avoided, the marginal external cost \(MSC - MPC\). Both conditions together give \(MSC - MPC \gt p \gt MPB - MPC\).
The option with the inequalities reversed would have the affected party pay more than the damage it avoids. The options built on \(MPC - MSC\) and \(MPC - MPB\) flip the signs of these gains; with a negative production externality \(MPC - MSC\) is negative, so it cannot exceed a positive payment.
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