Suppose two companies own adjacent oil fields. under the two fields is a common pool of oil worth $60 million. for each well that is drilled, the company that drills the well incurs a cost of $4 million. each company can drill up to two wells. what is the likely outcome of this game if each company pursues its own self-interest?
a. each company drills one well and experiences a profit of $26 million.
b. each company drills one well and experiences a profit of $22 million.
c. each company drills two wells and experiences a profit of $22 million.
d. one company drills two wells and experiences a profit of $32 million; the other company drills one well and experiences a profit of $16 million.

Final answer:

When two companies pursue their own interest with a common oil pool, they are likely to drill two wells each, resulting in a profit of $22 million for each, making option c the most likely outcome.

Explanation:

Suppose two companies own adjacent oil fields, with a common pool of oil worth $60 million underneath. Each well drilled incurs a cost of $4 million, and each company can drill up to two wells. When each company pursues its own self-interest in this scenario, the likely outcome is that each company drills two wells. Here's how the profit is calculated: The total value of oil is $60 million. If both companies incur the cost of drilling two wells each ($4 million x 4 wells = $16 million), the remaining profit is $44 million. This profit is divided equally between the two companies as the oil pool is common, resulting in a profit of $22 million for each company, after considering the $8 million expense for drilling the two wells.

This aligns with option c. It illustrates a classic case of the negative externality leading to over-drilling in pursuit of self-interest, where a common resource is exploited beyond the optimal point, reducing overall profit due to the additional costs incurred by each company.

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