ECO324 Chapter 3 —Modeling Market Failure

6. Absence of Property Rights

The Coase Theorem Ronald Coase (1910-2013), Nobel Laureate, 1991

Ronald H. Coase: On Economics

http://www.youtube.com/watch?v=04zFygmeCUA 1

Property Rights

• • • Valid claims to a good or resource that permit the use and transfer of ownership through sale For environmental goods, it’s unclear who “owns” rights Economics says it’s the

absence

of rights that matters, not who possesses them 2

Coase Theorem

• Proper assignment of property rights, even if externalities are present, will allow bargaining between parties such that efficient solution results, regardless of who holds rights – Assumes costless transactions – Assumes damages are accessible and measurable

In economics, a transaction cost is a cost incurred in making an economic exchange. It includes: search and information cost, bargaining cost, and enforcement cost.

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The Coase Theorem: An Example Dick owns a dog named Spot.

Negative

externality: Spot’s barking disturbs Jane, Dick’s neighbor. The socially efficient outcome maximizes Dick’s + Jane’s well-being. – If Dick values having Spot more

See Spot bark.

than Jane values peace & quiet, the dog should stay. Otherwise, the dog should go.

Coase theorem: The private market will reach the efficient outcome on its own…

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The Coase Theorem: An Example • • • CASE 1:

Dick has the right to keep Spot (Jane needs to pay Dick to get rid of Spot).

Benefit to Dick of having Spot = $500 Cost to Jane of Spot’s barking = $800 • Socially efficient outcome: Spot goes bye-bye.

Private outcome: Jane pays Dick $600 to get rid of Spot, both Jane and Dick are better off. Private outcome = efficient outcome http://www.youtube.com/watch?v=zwwDkCylj2g 5

• The Coase Theorem: An Example CASE 2:

Dick has the right to keep Spot (Jane needs to pay Dick to get rid of Spot).

Benefit to Dick of having Spot = $1000 Cost to Jane of Spot’s barking = $800 • • • Socially efficient outcome: See Spot stay.

Private outcome: Jane not willing to pay more than $800, Dick not willing to accept less than $1000, so Spot stays. Private outcome = efficient outcome 6

The Coase Theorem: An Example • CASE 3:

Jane has the legal right to peace & quiet (Dick needs to pay Jane to keep Spot).

Benefit to Dick of having Spot = $500 Cost to Jane of Spot’s barking = $800 • • Socially efficient outcome: Spot goes bye-bye.

Private outcome: Dick not willing to pay more than $500, Jane not willing to accept less than $800, so Spot goes bye-bye. • Private outcome = efficient outcome 7

• The Coase Theorem: An Example CASE 4:

Jane has the legal right to peace & quiet (Dick needs to pay Jane to keep Spot).

Benefit to Dick of having Spot = $1000 Cost to Jane of Spot’s barking = $800 • Socially efficient outcome: Spot stays.

• Private outcome: Dick pays Jane $900 to keep Spot, both Jane and Dick are better off. • Private outcome = efficient outcome 8

The private market achieves the efficient outcome regardless of the initial distribution of rights.

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Solution to Externalities

Government Intervention • Internalize externality by:

a private solution

– Assigning property rights, OR

public solutions

– Setting policy prescription, such as: • Set standards on pollution allowed

Ch4

• •

Tax polluter (= MEC at Q E ) Ch5

Establish a market and price for pollution

Ch5

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