Chapter 11: Coase Theorem Instructor: Dr. Michael A. Newsome 304-696-2613 [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 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 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. Always: 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.