The Tate Modern, an art museum in London, recently opened a new viewing platform. Directly across from the platform is a block of 4 luxury flats with glass exteriors. The owners of the flats sued the Tate Modern, claiming the new viewing platform made them feel as though they were "on display in a zoo." Suppose that the annual profits for the Tate Modern with the viewing gallery in place are $70,000, while if they do not use the platform their profits will fall to $30,000. Similarly, suppose that the flats across the street have a combined worth of $120,000 annually if there is no platform and no one can see into the flats, and $100,000 annually if the Tate Modern does have a platform where people can see into the flats. However, the Tate Modern can pay $30,000 to construct screens on the platform so as to block the view of the flats. Similarly, the flats can pay $5,000 to put in high-tech filtered windows that block the view of those on the platform while allowing those in the apartment to see out.
a) Given this situation, what is the socially efficient outcome? Explain.
Suppose, as what actually happened, the courts issued an injunction to the Tate Modern that states they cannot use their platform unless they come to an agreement with the owners of the flats that allows the Tate Modern to use the platform. Also suppose that the Tate Modern and the flat owners bargain over the agreement in the following manner. First, the Tate Modern decides whether to negotiate or not negotiate. If the Tate doesn't negotiate, they either do not use the platform or must install screens. If they do negotiate, they make an offer P to the flats in order to be allowed to use the platform. If the flats accept Pi, then the owners of the flats must decide whether or not to put in the high-tech windows. If the flats reject Pā, they make a take-it-or-leave-it counteroffer Pk. If the Tate Modern accepts this counteroffer, they must pay the flats Pk, and the flats then must decide whether to put in the high-tech windows or not. If the Tate Modern rejects this counteroffer, they must then decide between installing screens or not using the platform at all. Assume a very slight penalty to rejecting P; for both parties of $1 (think of this as the cost to Tate and the flat owners of continuing to bargain).
b) On the back of the prior page, depict this situation in a game tree.
c) Based on Subgame Perfection, what would you expect the outcome to be? Provide details using the game tree.
d) What if instead of an injunction ruling, the court issued a damages ruling requiring the Tate Modern to pay the flats for lost value, unless the Tate Modern can come to an agreement with the flats or if the flats voluntarily install high-tech windows. How would this change the game tree and expected outcome? Provide explanation.
e) Now, suppose instead of a block of 4 flats, there are in fact 150 flats, making transaction costs extremely high. From an efficiency perspective, is an injunction or damages ruling preferable? Explain.
