Question

Tim and James are neighbours in a flat. Tim is a musician who likes to compose loud music at home while James is a full time student who needs a quiet environment to stay at home. James consider the loud music from Tim as noise and disturb him in his study. Assume that the music provides a benefit of $60 to Tim but cost James $90.

(a) If Tim is not liable for the noise and both parties can negotiate at no cost, what will be an efficient outcome?

(b) If the law requires Tim to observe silence and can only make noise with James approval and both parties can negotiate with no cost, what will be an efficient outcome?

(c) If the negotiation cost is $50, under what situation will the efficient outcome occur?

Answer 1

a) If Tim is not liable for loud music and both parties can negotiate at no cost, then the efficient outcome would be, that, James can give $60 to Tim and ask him not to play loud music. By doing this, Tim would get the same benefit that he would have got by playing loud music and James can now study in the silent environment, which he values to be of $90 only at a cost of $60, which he had to pay Tim, so that Tim does not play loud music. So, Tim will neither be worse off nor be better off and James will have a benefit of $90 - $60 = $30.

b) If the law requires Tim to observe silence and he can play loud music only with the approval of James, the efficient outcome would be, that, Tim does not play music and James gets a silent environment to study. This is because the benefit received by Tim by playing loud music is of $60, whereas the loss incurred by James because of loud music will be $90. In this case, James would not agree for any amount which is less than $90 and Tim will not be ready to pay anything above $60. So, we can say that both will not be able to negotiate in this case.

c) If the negotiation cost is $50, then the efficient outcome would be that Tim does not play his loud music and James get a silent environment to study. This is because, with a negotiation cost of $50, the total cost of negotiation would exceed the benefits that will enjoyed by Tim and James. So, doing a negotiation will not be a rational decision as doing so will lead to loss in their benefits.

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