Chapter 11:Coase Theorem

Instructor: Dr. Michael A. Newsome

304-696-2613

newsome@marshall.edu

Part III: Common Property Resources: Thinking in Terms of Property Rights

No one has Exclusive Rights to a Common Property Resource.

It is possible to Define Public Goods and Congestible Goods in Terms of Property Rights

Problem:Property Rights Not Explicit or Defensible

Solution:Make Explicit and Defensible

“Tragedy of the Commons” …. Result of Common Property Resource Allocation

Marginal Benefit of Cow Marginal Cost of Cow

Farmer: The Increase in Profits the Cow brings in because it grazed in the Commons

The Decrease in Profits per Cow (due to the Extra Cow) Across All the Farmer’s Cows

Society: The Same The Decrease in Profits per Cow (due to the Extra Cow) Across All Cows

“Fugitive Property Rights”

Part IV: One Solution… Property Rights

Ronald Coase wrote “The Problem of Social Cost”

Coase realized that there was a “Reciprocal Nature to Externalities”.

Coase Theorem:

When Parties Affected by Externalities Can Negotiate Costlessly with One Another,

an Efficient Outcome Results No Matter How the Law Assigns Responsibility for Damages.

Example:

Imagine the doctor gets $60/day in damage from listening to noise, and

Confectioner receives $40/day in profits from making noise

Case 1: Doctor Given Rights to Noiseless Environment.Doctor Demands at least $60 to Listen to Noise.Confectioner will pay up to $40 to Make NoiseConfectioner cannot pay enough.

Confectioner closes: gets $0.Doctor keeps $60—all patients get service.

Case 2: Confectioner Given Rights to Noisy EnvironmentConfectioner Demands at least $40 to Stop Noise.Doctor will pay up to $60 to Stop the NoiseDoctor Pays Confectioner between $40-60

Confectioner closes: gets ~$40Doctor Nets ~$20—all patients get service.

Always: Patients Get Service and there is No NoiseProperty Rights Determine: Distribution of wealth

Same Efficiency Result Occurs Regardless of Who Has the Rights.

On Distributional Grounds the Parties Are Not Indifferent.

For Efficiency:

property rightscontracts allowedcontracts enforceableNegotiation costs low

Two important points:

1. The more parties to an agreement, the higher the transaction cost, the less likely there will be an agreement.

2. The larger the gains to any party, the more likely there will be an agreement.

Coase’s Rule:The most efficient laws and social institutions are the ones that place the burden of adjustment to externalities on those who can accomplish it at least cost.