Reference no: EM133428356

Case Study: The following question is from Ethan Bueno de Mesquita, Political Economy for Public Policy, 2016. A company is considering building a new factory. The factory will cost c to build. To operate, the factory requires 100 workers. Once operating, it will generate profits of π. If the company builds the factory and hires the workers at wage w, it makes a payoff of π - 100w - c If the company builds the factory but fails to hire workers, it makes a payoff of -c. If it doesn't build the factory it makes 0. The workers currently have jobs that pay a wage of v. The workers' payoff is equal to their wages (either at the new factory or in their current jobs).

Questions:

a Suppose the workers can be hired at their current wage-that is, w=v. For what values of c will the firm build the factory?

b. Suppose that, after the factory is built, the workers' union can make a take-it-orleave it wage demand to the firm. The firm's only choice is to pay that wage or have the factory not operate (thereby losing its up-front investment of

c). What demand will the union make? Anticipating this, for what values of c will the firm build the factory?

c. Explain how the difference between your answers to parts (a) and (b) are the result of a hold-up problem?

d. A similar type of hold-up problem arises between multinationals and developing countries seeking investment. One approach at arriving at an efficient solution, for example, might be to rely on international arbitration. What are some other potential responses?

e. What are the downsides of a reliance on international arbitration (if, for instance, the rule of law is important for economic development)?