Module 74 Featured Worksheet 2

The Coase Theorem

Solitude Yoga Studio (SYS) teaches early morning meditation classes in the only building located within miles of Brasswind's Horn Company (BHC). BHC produces trumpets and has always tested its trumpets at the same time each evening. Recently, BHC decided to change its production schedule so that it tests its trumpets early each morning, when it is cheaper to hire trumpet testers. But the trumpet testing means that SYS does not have the quiet needed to teach meditation classes. The total profits of the two firms before and after the schedule change are shown below.

1. What are the total returns (i.e. to both companies) with PM testing and with AM testing?

2. Which testing schedule is socially optimal (i.e. provides the highest combined returns)?

3. If there is no communication between the companies and there is no government intervention, when will BHC test its trumpets? Explain.

4. What is the cost to BHC to test in the evening?

5. What is the cost to SYS if BHC tests in the morning?

6. How much would SYS be willing to pay BHC to test in the evening?

7. How much would BHC need to receive to be willing to test in the evening?

8. If the two firms can negotiate at no cost, can they come to an agreement that results in the highest combined returns? Explain.

9. Is it fair to expect SYS to pay to eliminate the AM testing? Explain.