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Billss Railroad Company is small successful railroad that earns $2 million per year. Alexs Wheat Farms is a farming company that earns a modest $100,000

Billss Railroad Company is small successful railroad that earns $2 million per year. Alexs Wheat Farms is a farming company that earns a modest $100,000 of profits each year. The two companies have a problem: Bills trains throw sparks that start fires in Alexs adjacent grain fields. The cost of the damage to Alexs Farms amounts to $50,000 if no action is taken to fix the problem.

There are two ways to prevent the damage. One solution is for the railroad to put on a spark arrester that will prevent the sparks. The cost of the arrester is $100,000 for Bills Railroad. The second solution is for Alexs farms to plant a fire barrier of clover along the railway side of his field. The cost of the clover barrier is $20,000 for Alexs Farms.

The courts must decide who has the rights to their activity. The court could decide to grant the railroad the right to emit sparks (Railroad rights) or it could decide that the farmer has a right to an unburned field (Farmer rights). Assume that the companies divide any surpluses equally (using fair prices). For questions (a) through (k) assume that transaction costs are negligible. Clearly label your answers to each question with the corresponding letter, (a) through (l). (The tables are included in the question for your reference to help you answer the graded questions).

Table of profits under four different scenarios.

Farmer Alex

No Clover

Clover

Bills RR

No Arrester

Arrester

  1. What is the most efficient solution to the problem?

The court grants rights to Bills Railroad to emit sparks if it wishes. Assume transaction costs are zero.

Company

Non-Cooperative Solution

(Threat Values)

Cooperative Solution

Cooperative Surplus

Bills RR

Alexs Farms

Total

  1. If the court grants rights to Bills railroad to emit sparks, Bills threat value is __________.
  2. If the court grants rights to Bills railroad to emit sparks, Alexs threat value is __________.
  3. If the court grants rights to Bills railroad to emit sparks, the cooperative surplus is __________.
  4. If the court grants rights to Bills railroad to emit sparks, describe any payments that are made when arriving at a cooperative solution.

    The court grants rights to Alexs Farms to have its farms protected from fire. Assume transaction costs are zero.

    Company

    Non-Cooperative Solution

    (Threat Values)

    Cooperative Solution

    Cooperative Surplus

    Bills RR

    Alexs Farms

    Total

  5. If the court grants rights to Alexs farms to be protected from fire, Bills threat value is __________.
  6. If the court grants rights to Alexs farms to be protected from fire, Alexs threat value is __________.
  7. If the court grants rights to Alexs farms to be protected from fire, the cooperative surplus is __________.
  8. If the court grants rights to Alexs farms to be protected from fire, describe any payments that are made when arriving at a cooperative solution.
  9. What does the Coase Theorem say about which company should receive the rights?
  10. Does it matter to the parties who has the rights? Explain.
  11. Suppose that there are transaction costs amounting to $60,000 for each company (thats $120,000 of total transaction costs) to negotiate and draw up a contract that identifies the companies responsibilities and enforcement guidelines. Contrast the Normative Coase Theorem and the Normative Hobbes Theorem in fixing the neighbors problems.

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