Space heaters are dangerous. The U.S. Consumer Product Safety Commission estimates that more than 25,000 residential fires every year are associated with the use of space heaters, resulting in more than 300 deaths. This question asks you to think about the Coase Theorem and the assignment of liability from these accidents. Suppose a company could produce a space heater that is perfectly safe for $225 or a standard space heater for $200. Suppose further that a consumer who buys a space heater will receive $275 of benefits. If he buys a traditional space heater, he will incur (on average) $60 of damages but he will not incur damages if he purchases a safe model.
a. Show that efficiency requires the firm to produce safe space heaters.
b. Suppose the law says that firms are not liable for the damages associated with space heater accidents. Show that the firm will sell only safe space heaters.
c. Now suppose Congress passes a law that says firms are liable for the damages from space heaters, and so on average a firm that sells a standard space heater will have to pay $60 in damages. Show that the firm will produce safe space heaters.