Question

The focus of this problem is the Coase Theorem. There are several sub-parts to this problem. Please read each part carefully. In each case, the logic underlying your answer should be explicitly explained.

Consider a doctor whose ability to examine patients was disrupted by the noise of machinery operated by a confectioner (candy maker) in an adjacent building. The historic economic and legal view toward such a situation was simple: the confectioner's noise was harming the doctor and it ought to be restrained. Coase's insight was that this view completely overlooked the reciprocal nature of the problem: if we prevent the noise, we harm the confectioner. While answering the following questions, please keep this insight in mind.

Part 1

Suppose the benefit to the confectioner of continuing to make the noise is 40, while the cost of the noise to the doctor is 60. If the confectioner's only alternative to making the noise is to shut down, and the doctor cannot relocate his business, what is the efficient solution to the problem?

Part 2

If the confectioner is made liable for the damage, will he continue the production of candy? [To be liable for the damage means being required to compensate the doctor for any damage caused by the noise.]

Part 3

Suppose the law changes and now the confectioner is not liable for the damage to the doctor. How will this affect the confectioner's decision to shut down? Explain carefully.

Part 4

Suppose the data are changed. Suppose now that the benefit to the confectioner of operating is 60, and the benefit to the doctor in a noise-free environment is only 40. What is the efficient outcome in this case? Explain how the efficient outcome is reached under the two alternative allocations of the liability for damage.

Part 5

Revert to the cost and benefit assumptions of part 1. Except now the confectioner has the option of installing a soundproofing device that will completely eliminate the noise from his machines. The cost of this is 20, which means that if he installs it, his net gain from operating will fall from 40 to 20. As in part 1, the doctor will gain 60 if there is no noise (another way of saying that he will incur a cost of 60 if there is noise). What is the efficient outcome in this case? Again, explain the process by which the efficient outcome will be achieved if

a) the confectioner is liable for damage;

b) the confectioner is not liable for damage.

Answer 1

1)If the confectioner is not making noise, his loss is 40$ or he is not gaining $40. The doctor's loss is $60. So the efficient outcome would be when there is overall social benefit. So this would mean that when he chooses to make noise , the overall benefit would be (-)$20 and when he doesn't the overall benefit is $0. So he chooses not to make noise.

2) No, if he is made liable, he would not continue the production because the net cost would be a loss of $20 which is because he needs to pay $60 for the profit of $40.

3) If the confectioner is not liable for the damage,then he would continue the production and the doctor would pay him something between $40 to $60 to let him stop the production. This si because $40 would be the benefit he is initially getting and $60 is the cost the doctor is having.

4) The efficient outcome would be letting the confectioner to make the noise because the overall benefit is more than he is making noise than when he is not making noise.

in this case if the doctor has the right for a quiet environment then the confectioner would pay the doctor for making the noise as he would be benefited from the decision on the other hand if the confectioner is not liable for a quiet environment then the doctor would need to pay him more than the benefit he is getting from making the noise

5) in case when the confectioner can install a soundproofing which would cost him dollar 20 e then there would be 2 cases to reach efficient outcome.

If the confectioner is liable to install soundproofing then his cost would be $ 20 that would mean is benefit would be $ 20 also now the doctor would also be benefiting which would mean the overall benefit would be $20 + 60 = $80.

If the construction is not liable for the damages then he would not install the soundproofing as it reduces his profits. This would mean that he would continue to earn a benefit of 40 while the doctor would have the loss of 60 or that the doctor would not be getting anything. This would definitely be less than the benefits from soundproofing.

so the efficient outcome is when the confectioner installs a soundproofing