The Big Choo Choo Company (BCCC) owns a rail line from the town of "Isolated" to the coastal port of "Notso." It cost them $20 million to build the rail line in 1983. It is now 1997. The Small Gold Company (SGC) has discovered gold deposits near Isolated that they want to export overseas. There are almost 20,000 ounces of gold in the mine. The current price of gold is $400 per ounce and it is expected to remain at that level over the life of the mine. SGC want to transport the gold to the port using the Notso-Isolated rail line. They have no alternative transportation substitutes available.
a. Suppose that it costs BCCC $5 per ounce to transport the gold from Isolated to Notso. They have free capacity on the line. It costs SGC $10 per ounce in shipping from Notso to their overseas buyers. It will cost SGC $1 million to make the mine operational and $100 to extract each ounce of gold. BCCC and SGC negotiate over the rail freight charge per ounce for SGC's gold. What is SGC's Willingness-to-Pay for transport of gold, as a per-ounce-price? What is BCCC's Willingness-to-Sell (as a per-ounce price)? Use decision trees to illustrate your answer.
b. Now suppose that SGC can build an airport close to Isolated for $2 million and purchase a cargo plane for $500,000 that could ship the gold straight to its overseas buyers for $25 per ounce. Does this affect WTP or WTS? What are the new values of WTP and WTS?
c. Is it likely that SGC will build the airport? What considerations might make such an outcome more likely?