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(1) Determine the efficient amount of investment. (ii) Suppose that there is no contract and the two parties bargain expost according to the Nash bargaining solution. Is the investment optimal? Point out the externality. (iii) Suppose that the parties sign a contract specifying that the buyer has the right to buy the good at a given price p. Is this contract efficient? What if the supplier has the right to sell at a given price?

(1) Determine the efficient amount of investment. (ii) Suppose that there is no contract and the two parties bargain expost according to the Nash bargaining solution. Is the investment optimal? Point out the externality. (iii) Suppose that the parties sign a contract specifying that the buyer has the right to buy the good at a given price p. Is this contract efficient? What if the supplier has the right to sell at a given price?

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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please help me solve exercise 1 and explain every step. thank you!

Exercise 1** In the text, it is assumed that the supplier's investment reduces his production cost. Assume instead that the ex ante investment affects the quality of the product and thus the value to the buyer. The buyer's ex post value is v(I) = 31 – 11². Hence, the buyer's surplus in case of trade is v(I) – p. The supplier's surplus is then p− c – I (where c < ½ is now a constant production cost). Suppose that I (and, hence, v ) is observable by the buyer; however, it is not verifiable by a court, so that it cannot be specified by a contract. (i) Determine the efficient amount of investment. (ii) Suppose that there is no contract and the two parties bargain expost according to the Nash bargaining solution. Is the investment optimal? Point out the externality. (iii) Suppose that the parties sign a contract specifying that the buyer has the right to buy the good at a given price p. Is this contract efficient? What if the supplier has the right to sell at a given price? (iv) What happens if the supplier is given the right to choose the price ex post?
Transcribed Image Text:Exercise 1** In the text, it is assumed that the supplier's investment reduces his production cost. Assume instead that the ex ante investment affects the quality of the product and thus the value to the buyer. The buyer's ex post value is v(I) = 31 – 11². Hence, the buyer's surplus in case of trade is v(I) – p. The supplier's surplus is then p− c – I (where c < ½ is now a constant production cost). Suppose that I (and, hence, v ) is observable by the buyer; however, it is not verifiable by a court, so that it cannot be specified by a contract. (i) Determine the efficient amount of investment. (ii) Suppose that there is no contract and the two parties bargain expost according to the Nash bargaining solution. Is the investment optimal? Point out the externality. (iii) Suppose that the parties sign a contract specifying that the buyer has the right to buy the good at a given price p. Is this contract efficient? What if the supplier has the right to sell at a given price? (iv) What happens if the supplier is given the right to choose the price ex post?
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