The Big Choo Choo Company (BCCC) owns a rail line from the town of Isolated to the

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Question:

The Big Choo Choo Company (BCCC) owns a rail line from the town of “Isolated” to the coastal port of “Notso.” It cost them $20 million to build the rail line in 2016. It is now 2023. The Small Gold Company (SGC) has discovered gold deposits near Isolated that they want to export overseas. There are almost 20,000 ounces of gold in the mine. The current price of gold is $400 per ounce, and it is expected to remain at that level over the life of the mine. SGC want to transport the gold to the port using BCCC’s Notso-Isolated rail line. From Notso, SGC will ship the gold to their overseas buyers. They have no alternative transportation substitutes available.

(a) Suppose that it costs BCCC $5 per ounce to transport the gold from Isolated to Notso. They have free capacity on the line. It costs SGC $10
per ounce in shipping from Notso to their overseas buyers. It will cost SGC $1 million to make the mine operational and $100 to extract each ounce of
gold. BCCC and SGC negotiate over the rail freight charge per ounce for SGC’s gold, before the mine is made operational. What is SGC’s Willingness-to-Pay for transport of gold, as a lump-sum payment? What is BCCC’s Willingness to- Sell, as a lump-sum payment? What is the negotiated payment likely to be? Note: If you find it more intuitive, you can work out WTP and WTS as a per-ounce price; but it’s important to remember that the parties agree on both (1) the quantity to be transported and (2) the total lump sum to be paid. In some other applications, that will be important.

(b) Now suppose that SGC can build an airport close to Isolated for $2 million and purchase a cargo plane for $500,000 that could ship the gold
straight to its overseas buyers for $25 per ounce. Does this affect WTP or WTS? What are the new values of WTP and WTS? What is the negotiated
payment likely to be?

(c) Is it likely that SGC will build the airport? To answer, think about what role the airport played in part (b) of the question.