Billss Railroad Company is small successful railroad that earns $2 million per year. Alexs Wheat Farms is a farming company that earns a modest $100,000 of profits each year. The two companies have a problem: Bills trains throw sparks that start fires in Alexs adjacent grain fields. The cost of the damage to Alexs Farms amounts to $50,000 if no action is taken to fix the problem.

There are two ways to prevent the damage. One solution is for the railroad to put on a spark arrester that will prevent the sparks. The cost of the arrester is $100,000 for Bills Railroad. The second solution is for Alexs farms to plant a fire barrier of clover along the railway side of his field. The cost of the clover barrier is $20,000 for Alexs Farms.

The courts must decide who has the rights to their activity. The court could decide to grant the railroad the right to emit sparks (Railroad rights) or it could decide that the farmer has a right to an unburned field (Farmer rights). Assume that the companies divide any surpluses equally (using fair prices). For questions (a) through (k) assume that transaction costs are negligible. Clearly label your answers to each question with the corresponding letter, (a) through (l). (The tables are included in the question for your reference to help you answer the graded questions).

Table of profits under four different scenarios.

		Farmer Alex
		No Clover		Clover
Bills RR	No Arrester
	Arrester

1. What is the most efficient solution to the problem?

The court grants rights to Bills Railroad to emit sparks if it wishes. Assume transaction costs are zero.

Company	Non-Cooperative Solution (Threat Values)	Cooperative Solution	Cooperative Surplus
Bills RR
Alexs Farms
Total

2. If the court grants rights to Bills railroad to emit sparks, Bills threat value is __________.
3. If the court grants rights to Bills railroad to emit sparks, Alexs threat value is __________.
4. If the court grants rights to Bills railroad to emit sparks, the cooperative surplus is __________.
5. If the court grants rights to Bills railroad to emit sparks, describe any payments that are made when arriving at a cooperative solution.

   The court grants rights to Alexs Farms to have its farms protected from fire. Assume transaction costs are zero.

   Company	Non-Cooperative Solution (Threat Values)	Cooperative Solution	Cooperative Surplus
   Bills RR
   Alexs Farms
   Total

6. If the court grants rights to Alexs farms to be protected from fire, Bills threat value is __________.
7. If the court grants rights to Alexs farms to be protected from fire, Alexs threat value is __________.
8. If the court grants rights to Alexs farms to be protected from fire, the cooperative surplus is __________.
9. If the court grants rights to Alexs farms to be protected from fire, describe any payments that are made when arriving at a cooperative solution.
10. What does the Coase Theorem say about which company should receive the rights?
11. Does it matter to the parties who has the rights? Explain.
12. Suppose that there are transaction costs amounting to $60,000 for each company (thats $120,000 of total transaction costs) to negotiate and draw up a contract that identifies the companies responsibilities and enforcement guidelines. Contrast the Normative Coase Theorem and the Normative Hobbes Theorem in fixing the neighbors problems.