Chapter 11:
Coase Theorem
Instructor: Dr. Michael A. Newsome
[email protected]
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
Property Rights Not Explicit or Defensible
Make Explicit and Defensible
“Tragedy of the Commons” ….
Result of Common Property Resource Allocation
Marginal Benefit of Cow
Marginal Cost of Cow
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
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.
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 Noise
Confectioner cannot pay enough.
Confectioner closes: gets $0.
Doctor keeps $60—all patients get service.
Case 2:
Confectioner Given Rights to Noisy Environment
Confectioner Demands at least $40 to Stop Noise.
Doctor will pay up to $60 to Stop the Noise
Doctor Pays Confectioner between $40-60
Confectioner closes: gets ~$40
Doctor Nets ~$20—all patients get service.
Property Rights Determine:
Patients Get Service and there is No Noise
Distribution of wealth
Same Efficiency Result Occurs
Regardless of Who Has the Rights.
On Distributional Grounds the Parties Are Not Indifferent.
For Efficiency:
property rights
contracts allowed
contracts enforceable
Negotiation 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.

ECN405 Lecture Ch11 (Market Failure and Coase)