1. Parties "A" and "B" are next-door neighbors. Every evening B plays loud music that keeps A awake at night after a hard day of work. A values his home at $5,000, but if he is unable to sleep soundly each night this value falls to $3,000. B gets $1,000 in value from listening to loud music.
a. Initially assume that bargaining between A and B is precluded by the presence of high transactions costs. Determine and carefully explain whether efficiency is achieved under each of the following legal rules:
i. Rule 1: B has the unconditional right to play loud music
ii. Rule 2: A is entitled to compensatory damages from B
iii. Rule 3: A is entitled to a legal injunction against B.
In each instance, be sure to identify the payoffs to each party and the joint payoffs under each rule.
b. Now assume that transactions costs turn sufficiently low so that bargaining is no longer precluded between A and B. In this case, for each of the three legal rules in part (a), specify:
i. the threat values for A and B,
ii. the cooperative surplus that can be gained through bargaining,
iii. what the bargain will be, and
iv. the payoffs realized by A and B after bargaining assuming the "reasonable" (i.e.,
Nash bargaining) solution to the bargaining game.
c. Carefully explain how the results of parts (a) and (b) relate to the conclusions of the Coase Theorem.