Al owns a shoe factory with noisy machines which disturb his neighbor Bob. The v

Question

Al owns a shoe factory with noisy machines which disturb his neighbor Bob.

The value of the factory (the present discounted value of its future profits) is $1,000,000. Producing shoes without making noise would be much more costly – if Al were forced to run his factory silently, the value of the factory would fall to $400,000.

It is estimated that the harm done to Bob (having to endure the noise), now and in the future, is worth $100,000.

What is the efficient outcome – for the factory to shut down, to run silently, or to run noisily?

Suppose Bob was granted an injunction to stop the factory from making noise.

If Bob enforced the injunction, Al would have to run the factory silently.What would be Al’s, and Bob’s, payoffs?

If Al and Bob tried to negotiate to deal under which Bob would not enforce the injunction, what would be each side’s threat point during negotiations?

If Bob agreed not to enforce the injunction, what would be the gains from cooperation?

If the gains from cooperation were split evenly between the two sides, what would each side’s payoff be?How much would Al be paying Bob not to enforce the injunction?

Suppose instead that Al were required to pay Bob permanent damages if he wanted to continue making noise. What would Al’s, and Bob’s, payoffs be?

Explanation / Answer

Payoff:

600,000 to Al from running silently and -100,000 from paying permanent damages, or payoffs of 100,000 to Bob if there is no harm done and 0 if the factory runs noisily.  

hence it should run noisily,

Payoff= $1,000,000 - $100,000 = $900,000 from running noisily vs. 400000$ and 0$ as payoffs from other options

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