Question

If soda is packaged in bottles, the production cost per unit is 40 cents, the chance of an accident is 1 in 100,000, and the loss if an accident occurs is $10,000. The expected accident loss per unit is 10 cents, that is 1/100,000 x $10,000. If soda is packaged in cans, the production cost is 43 cents, the chance of an accident is 1 in 200,000, the loss if an accident occurs is $4,000, and the expected accident loss is 2 cents (1/200,000 x $4,000). That is, cans are less likely to explode than bottles, and on average do less damage when they do explode since there is no flying glass. Under strict liability, will the efficient number of sodas be produced? That is, will consumers who value soda less than the total cost (including expected accident costs) refrain from drinking it, and consumers who value soda at or above the total cost of the soda drink it? Explain your answer.

Answer 1

Broadly Speaking;

Case 1: Will consumers refrain from drinking soda bottles?

Ans — Consumers will definitely refrain from drinking soda and in turn prefer cans since the cost of expected accident loss of cans is lower than that of soda.

1. Soda Bottles,

Expected Accident Loss Cost (EAL) = wX + P(x).A(x)

Or, EAL = 0.40(1) + (1/100,000)(1).10000(1)

Or, EAL = 0.40 + 0.10 = $ 0.50/bottle

2. Cans,

Expected Accident Loss Cost (EAL) = wX + P(x).A(x)

Or, EAL = 0.43(1) + (1/200,000)(1).4000(1)

Or, EAL = 0.43 + 0.02 = $ 0.45/can

Case 2: Will consumers drink soda bottles?

Ans — The can will be used regardless of the price of precaution because the soda bottle Company can be held responsible for any precaution it does not take and therefore has to bear all the costs attached with it.