Rules favour the residents: The residents enjoy the property right

Now suppose we are in legal regime II, where the residents can demand payment from the factory in exchange for granting the factory the right to produce. Then, in the absence of bargaining between the factory and the residents, the best that the factory can do is to produce at point II in Figure 3.4.3. Again, this is not an efficient outcome - there are other allocations which make both parties strictly better off.

Suppose the factory tries to persuade the residents to increase its production by offering them money in exchange for an increase in Q. Depending on the bargaining power of the parties and in the absence of transaction costs (both of which we examine in detail below), the parties could keep exchanging increases in Q for decreases in money until a point like % is reached, where there are no remaining gains from trade. Note again that this specific example illustrates that both parties are better off as a result of such trades, and that the final level of production, Qn is greater than the level that would have been produced in the absence of bargaining. The factory ends up with less money than it initially started with, and the residents have to put up with more y.

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