2. Smith can produce with or without a filter on his smokestack. Production with

Question

2. Smith can produce with or without a filter on his smokestack. Production without a filter results in greater smoke damage to Jone. The relevant gains and losses are as follows: Gains to Smith: $200/wk with filter; $245/wk without filter. Damage to Jones: $35/wk with filter; $85/wk without filter. a. If Smith is not liable for smoke damage and there are no negotiation costs, will he install a filter? Explain carefully. b. How, if at all, would the outcome be different if Smith were liable for all smoke damage and the cost of the filter were $10/wk higher than indicated in the table? Explain carefully.

Explanation / Answer

With Filter: Smith Gain: 200/ wk Jones Damage: 35/ wk Without filter: Smith Gain: 245/wk Jones Damage: 85/ wk a) Yes, if Smith is not liable, he won't install filter since his gains are more. b) If Smith were liable for all smoke damage, the excess damage would be 85-35 = 50/wk without filter as compared to with filter. If filter is used, the cost would be 10 + 45 = 55/wk If not used, cost would be 50/ wk Hence, the decision wuld not change

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