|Before||Do nothing||SD wall||.Pacifica wall||Both wall||SD floor & wall||SD floor & wall+Pac wall||SD sells out|
Max SD profits are $200,000, which occur under two scenarios: doing nothing, and with Pacifica installing its own insulation. Max Pacifica profits are $270,000 if Pacifica installs wall insulation and SD installs both floor and wall insulation. The most efficient allocation of resources (defined as maximizing joint profits) is joint profits of $400,000, which occurs if Pacifica installs wall insulation and SD installs both floor and wall insulation. This assumes that the $270,000 figure for Pacifica profits is net of the $30,000 cost of Pacifica wall insulation.
First, letís make sure we agree on the economic results of the different scenarios.
The best approach for Pacifica is to pay $30,000 to install its own wall insulation and pay $70,000 to SD to install wall and floor insulation which would result in Pacifica profits of $200,000.
SD may bargain for more than its costs, in which case Pacifica should be willing to pay up to $150,000, which would leave it as well off as the best that it can achieve without SD doing anything (Pacifica installs wall insulation, SD does nothing, and Pacifica has profits of $120,000)