Consider a version of the property-right model studied in class involving a buyer (Simon) and a seller (Jonny). The timing of the game is as follows. Initially the parties cannot write a contract on investment or on sharing surplus. At this point, Jonny can make an investment that costs either 0 (no investment) or $600 (positive investment). This investment is sunk and specific to trading with Simon. After the investment has been sunk, and contracting becomes possible, so the parties negotiate. The ex post surplus generated is either 0 with zero investment or $1000 if Jonny made a positive investment. Trade occurs (or does not) between the two parties and the game ends.
a. Draw a timeline of the game. What is the ex-ante period and the ex-post period in this model?
b. What is the first-best level of investment? Explain.
c. Now assume that property rights can be assigned to either party of an asset critical to this production process. If Simon owns the asset he will receive 50% of the ex post surplus. If Jonny owns the asset he will receive 75% of the ex post surplus. In this incomplete contracting environment, who should own the asset? Explain your answer in the context of the key predictions of the property-rights model.
d. Now thinking generally (outside the confines of this question), what are the key limitations of the property-rights model? Do you think it explains the modern publicly traded corporation?