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1. A power plant is located next to a cnal mine. The power plant uses coal from the mine, and the mine uses electricity from
1. A power plant is located next to a cnal mine. The power plant uses coal from the mine, and the mine uses electricity from the power plant. The purpose of this problem is to study the optimal ownership structure for this relationship. The plant and the mine are each rim by a risk neutral manager who can make costly investments that affect the values of both operations. Specif ically, the power plant manager can invest in the reliability of electricity delivery, which benets both the coal mine and the power plant's other cus tomers. We represent this choice by p, the power plant manager's mst is $02. The coal mine operator can choose the quality of coal extracted from the mine; again this affects both the power plant and the mine's other cus tomers. Represent this choice by m and its cost by %m2. The expected revenue from the power plant's operations when the choices are (p, m) is P1p+ Pgm, while the expected revenue for the mine is 0110+ 02m. That is, each manager makes investments, and the value generated by each operation depends on both investments Before the investments are made, the managers can sign a contract spec ifying an ownership structure. The ownership structure determines whether the two operations are integrated, and if so, which manager will own the other's asset. {a} Suppose that both p and m. are contractible. What choices of p and us do you expect the managers to agree to? (b) New, and for the rest of the problem, suppose that neither p nor as are contractible. The joint revenues from the two operations are split by the managers via Nash bargaining. First consider Nonintegration. In this case
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