CONTRACTS – Exceptions To Coase’s
Theorem – Empty Core
October 31, 2006
Exceptions to the Theorem of Coase
• Coase Theorem
• Exceptions To Coase Theorem
• Transaction Costs - October 17, 2006
• Asymmetric Information - October 24, 2006
• Empty Core - October 31, 2006
Exceptions to the Theorem of Coase
• COLOUR CODE FOR GRAPHS
• Marginal Cost Curve for Agent (firm, individual)
under a strict liability rule
• Marginal Cost Curve for Agent (firm, individual)
under a no liability rule
• Marginal Cost Curve for Agent (firm, individual)
under a negotiated contract that follows the Theoem
of Coase
• Demand Curve for the Agent’s output
• Marginal Revenue Curve
Exceptions to the Theorem of Coase
• COLOUR CODE FOR GRAPHS
• Expected Marginal Cost Curve for Agent (firm,
individual)
Exceptions to the Theorem of Coase
• COLOUR CODE FOR GRAPHS (con’t)
• Average Cost Curve for Agent (firm, individual) with
no transaction costs
• Average Cost Curve for Agent (firm, individual) with
transaction costs
• Profit of Agent (firm, individual)
• Portion of profit traded in exchange for property
rights
• Portion of profit lost due to a trade in property
rights
• Portion of profit lost due to transaction costs
Exceptions to the Theorem of Coase
Theorem of Coase
Review
Before Coase
The common law was believed to have
had little practical deterrence against
polluters.
Excise taxes or fines were proposed as
the “efficient” way of internalizing the cost
of harm against property owners
While not diminishing the precautions
taken by victims of such harm.
Before Coase
The polluter pays the marginal cost of the
harm it causes.
The victim must not receive a payment for
the harm endured if that harm could have
been avoided by the victim at lesser cost.
Theorem of Coase
The contract replaces the market as the Pareto improving
mechanism
Social surplus increases and is Pareto optimal under the Coasean
contract.
The least cost available Pareto improving technology is applied
No party can be worse off.
Pareto optimal social surplus means efficient use the property.
Incompatible uses are converted to compatible uses.
Social surplus is improved by the same amount irregardless of
which Agent has been granted property rights.
The distribution of the “equally improved” surplus can vary depending on
which agent has the property rights.
Property rights are exchangeable or transferable. A “market” for such
property rights is possible
Theorem of Coase
• In Sudbury, Ontario the government
enacted “smoke easements” that were
purchased by and transferable to the air
polluters
Theorem of Coase
• Agent 1
• Agent 2
P
D
CMC
S
PM
Maximum Joint
Social Surplus
a1
a2
Exceptions to the Theorem of Coase
Exceptions to the Theorem of Coase
Exceptions to the Theorem of Coase
The Coase theorem collapses under
high transaction costs
many parties
asymmetric information
coalitional instability (empty core)
Exceptions to the Theorem of Coase
Exceptions to the Theorem of Coase
Transaction Costs
Exceptions to the Theorem of Coase
Transaction Costs
• Perfectly Competitive-Agent 1 • Monopoly Market – Agent 1
P
D
SATC
+ TC
MC1
SATC
PM
PPC
Transaction
Costs
a1
S = MC1
LATC
S
SATC
Exceptions to the Theorem of Coase
Transaction Costs
• High Transaction
Costs
INJUNCTION
Low Transaction
Costs
DAMAGES
Exceptions to the Theorem of Coase
Transaction Costs
What is the most efficient or most socially
optimal way of enforcing a strict liability
rule:
(a) damages only
(b) damages and injunction
Exceptions to the Theorem of Coase
Transaction Costs
Under a no liability rule, with:
(a) one polluter
(b) many property owners
harmed
high transactions costs prevent a
collective bribe without avoidance of free
riding
Exceptions to the Theorem of Coase
Transaction Costs
Under a strict liability rule, with:
(a) one polluter
(b) many property owners
harmed
One owner could hold out for a bribe that
would extract the entire surplus of the
polluter.
Exceptions to the Theorem of Coase
Transaction Costs
Under the strict liability rule, with:
(a) one polluter
(b) many property owners
harmed
The “damages only” approach has been applied
in the United States by adoption of the
“reasonable use” doctrine
Exceptions to the Theorem of Coase
Transaction Costs
• As McKie v. KVP showed, the common
law applied by the courts in Canada did
not adopt the “damages only” approach
• In both the Sudbury and KVP cases, the
legislature applied a “damages only”
rule in the interests of local economics
Exceptions to the Theorem of Coase
Transaction Costs
If two or more owners hold out, the
polluter would have to shut down
This is what Justice Middleton believed to
be the case with Sudbury farmers when
he denied them injunctive relief but
damages only against the air polluters
Exceptions to the Theorem of Coase
Transaction Costs
• It may be less costly for the polluters to
internalize the pollution than to incur
the transaction costs to ascertain the
true level of harm in damages.
•
•
•
•
studies
experts
hiring lawyers
going to court
Exceptions to the Theorem of Coase
Transaction Costs
• Professor Dewees concluded that
injunctive relief, if this had been
allowed by Justice Middleton, at
Sudbury, might have succeeded in
forcing the companies to internalize the
costs and pursue optimal abatement
Exceptions to the Theorem of Coase
Transaction Costs
• T = 0 and Imperfect Information:
•
If a "polluter" cannot be persuaded to
settle for damages, because they suspect the
“owner" is cheating, a tougher remedy is the
injunction which can force a firm to shut
down.
• So the polluter might be more inclined to
"agree" to internalize the costs rather than
risk being shutdown. (Note - on the evidence
this approximates the K.V.P. case)
Exceptions to the Theorem of Coase
Transaction Costs
• In the wake of the Sudbury and KVP
cases, the expansion of government
invention in the market place came
through various boards such as public
health, regulation of professionals, slum
housing, and local pollution.
Exceptions to the Theorem of Coase
Exceptions to the Theorem of Coase
Asymmetric Information
Exceptions to the Theorem of Coase
Asymmetric Information
• Rules that compensate for market
failures
•
•
(a) moral hazard
(b) adverse selection
Exceptions to the Theorem of Coase
Asymmetric Information
• High Transaction
Costs
Low Transaction
Costs
INJUNCTION
DAMAGES
PERFECT INFORMATION
DAMAGES
INJUNCTION
IMPERFECT
INFORMATION
Exceptions to the Theorem of Coase
Asymmetric Information
What is the most efficient or most socially
optimal way of enforcing a strict liability
rule:
(a) damages only
(b) damages and injunction
Exceptions to the Theorem of Coase
Asymmetric Information
• Protection of Possession
• In trespass actions, where intent to
interfere with property rights is evident,
the injunction against the trespasser is
available.
• This is especially true when transaction
costs are high.
Exceptions to the Theorem of Coase
Asymmetric Information
Under the strict liability rule, the
“damages only” approach becomes
inefficient if the courts underestimate the
damages – for example – the harm is
ongoing
Exceptions to the Theorem of Coase
Asymmetric Information
• In Sudbury, Ontario the government
measures underestimated the damages
imposed on the farmers by the air
polluters – for example – future
damages when the harm is ongoing
Exceptions to the Theorem of Coase
Asymmetric Information
• In Sudbury, Ontario why did INCO build
the world’s tallest smokestack?
• Required by technology?
• Render air pollution identification more difficult
so that private nuisance suits are more difficult
to prove or
• Prosecution under the Ontario Environmental
Pollution Act more likely to be unsuccessful
Exceptions to the Theorem of Coase
Exceptions to the Theorem of Coase
Asymmetric Information – Breach Of Contract
Exceptions to the Theorem of Coase
Asymmetric Information
• .
CONTRACT
PERFORMANCE
OF CONTRACT
BREACH OF
CONTRACT
Exceptions to the Theorem of Coase
Asymmetric Information
• a = level of precaution invested by the
agent-promisor (Agent 1) against
breach of contract against (Agent 2)
1
• a = level of reliance invested by the
agent-promisee (Agent 2) in Agent 1
(polluter)
2
Exceptions to the Theorem of Coase
Asymmetric Information
• p(a ) = Probability of No Breach
1
• Probability of Performance
• A Completed Contract
• p’(a ) > 0
1
• More effort results in more precaution against
breach
• p’’(a ) < 0
1
• Diminishing “returns” to precaution as more
effort invested
Exceptions to the Theorem of Coase
Asymmetric Information
• p(a ) = Probability of No Breach
• Why would one expect a to be
suboptimal without a rule?
• A cannot observe a
• A knows that A cannot observe a
• A will apply less that optimal a unless
it can be assured that doing so will not
minimize TOTAL expected damages
1
1
2
1
1
1
2
1
1
Exceptions to the Theorem of Coase
Asymmetric Information
• “Liability rule” or “liability marginal
cost curve” for Agent 1 is added in
orange to the joint social surplus of the
parties
• Max [p(a )R (a ) + [1 - p(a )]R (a )]
- a - a - [1-p(e )]D
2
P
1
2
1
2
NP
1
2
e
Exceptions to the Theorem of Coase
Asymmetric Information
• Imperfect Information
$C1
•Decreasing Marginal Costs Due to Precaution
•Increasing Marginal Costs Due To Production
Strict Liabilty Rule –
MC1
Contracted Liability
Rule – MC1
Expected Liability –
MC1
a1
Exceptions to the Theorem of Coase
Asymmetric Information
• If the expectation damages rule is
focused entirely on A this will create a
second or “double” moral hazard
• What is it?
• A cannot observe a
• A knows that A cannot observe a
• A will apply less that optimal a unless
it can be assured that doing so will not
maximize TOTAL expected damages it
receives from A
1
1
2
2
1
2
2
1
•
2
Exceptions to the Theorem of Coase
Asymmetric Information
• p(a U a ) = Probability of No Breach
• p(a U a ) = p(a ) + p(a ) - p(a ∩ a )
1
2
1
2
1
2
1
2
• p(a U a ) = p(a ) + p(a ) - p(a )p(a )
1
2
1
2
1
2
Exceptions to the Theorem of Coase
Asymmetric Information
• 1 - p(a U a ) = Probability of Breach
• p(a U a ) = 1 - p(a ) - p(a ) + p(a )p(a )
1
1
•
2
2
1
2
1
2
Exceptions to the Theorem of Coase
Exceptions to the Theorem of Coase
Asymmetric Information - Screening
Exceptions to the Theorem of Coase
• .
CONTRACT
PERFORMANCE
OF CONTRACT
BREACH OF
CONTRACT
LOW
DISCLOSURE
PARTY
HIGH
DISCLOSURE
PARTY
Exceptions to the Theorem of Coase
Asymmetric Information - Screening
• A principal in a
• A court in a private
private bilateral
bilateral agency
contract
relationship writes
relationship writes a rule that may
a contract that
serve to “sort” or
may serve to
“separate”
“sort” or
contracts into
“separate” agents
more efficient
into more efficient
outcomes
contracts
Expectation Damages
Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145
A Court imposes a
“complete” rule with the
agents and principals
In this case two
“different” agents –
“two” different contracts
“two” different rules
EH
EL
H – high disclosure
principal and agent
L- low disclosure
principal and agent
Expectation Damages
Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145
The objective of the rule is that the two (2)
types of principals reveal themselves
through the choice of disclosure the
principals reveal and the agents receive
This results in two distinct and separate
damages measures for two distinct and
separate principals (buyers, plaintiffs)
Expectation Damages
Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145
EH
Expectation Damages
Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145
The alternative, or “one size fits all” rule
imposes a negative “non-disclosure”
externality on low-disclosure agents
(pooling)
Exceptions to the Theorem of Coase
Asymmetric Information – Screening
• The court frequently “separates” the
contracts that private parties negotiated as
“pooling contracts” in order to increase
“social surplus”
• How? By allowing:
• Inequality of bargaining defences
• Restraint of trade defences
• Note – in the market environment, such
contracts would deter high quality types from
entering the market – a form of adverse
selection
Exceptions to the Theorem of Coase
Asymmetric Information – Screening
• There are underlying questions that arise in
assessing the way courts address contract
types:
• What is the underlying probability distribution of contract
types
» Is it uniform?
» Is it normal (bell curve)?
» Is it some other type of distribution?
• Probability distribution types can effect the type of rules a
court might design. Court ordered auctions frequently
reflect
» More than two types of buyers
» More than one possible equilibrium price
Exceptions to the Theorem of Coase
Asymmetric Information
• When issues and outcomes become too complicated,
courts have developed “deference” to allow more
“expert’ tribunals “sort out” the parties, subject to
certain basic procedural guidelines
• In 1863, measures enacted for the demolition of
"slum housing" were reviewed by the courts which
concluded that, in the absence of express statutory
language to the contrary, occupants must either
receive notice of a decision pending or an opportunity
to show cause why a decision taken should not be
acted upon.
• Cooper v. Wandsworth Board Of Works (1863), 14 C.B.N.S. 180 at
194, 143 E.R. 414 at 420
Exceptions to the Theorem of Coase
Empty Core
Exceptions to the Theorem of Coase
Core
.
Agent 1 creates a harmful
nuisance that hurts
Agent 2 economically.
Agent 2 has lost the
exclusive use to its
property rights to
protect it against
pollution
Exceptions to the Theorem of Coase
Core
The legal problem of nuisance now
becomes a contract problem:
Agent 2 wishes to make a payment to Agent 1 (a
bribe) to induce Agent 1 to reduce its output
from the market or private efficiency level of aP1
= 5/6.
What bribe is Agent 2 willing to pay for a given
level of output aC1 < aP1 = 5/6?
Exceptions to the Theorem of Coase
Core
The “optimal” bribe or transfer payment
lies within the interval:
25/48 < PAYMENT < 25/36
This interval is called the “core” of the
contract, since any point in the interval
would be a Nash equilibrium
Exceptions to the Theorem of Coase
Core
• A coalition between three or more
agents is unstable (no Nash
equilibrium) if an allocation can be
blocked by an alternative coalition, that
is, there is a threatened breakaway or
objection to the coalition by one or two
of the agents.
Exceptions to the Theorem of Coase
Core
• The core refers to allocations that are
not dominated by what individual
agents can achieve either
independently or as part of any other
potential coalition.
• So the core is a set of stable points at
Nash equilibrium
Exceptions to the Theorem of Coase
Core
• Example: What is the core in the
standard prisoners dilemna game?
• It would be the point where the players’
strategies (reaction curves, incentive
compatibility constraints) intersect
• So cores are not necessarily Pareto
optimal
Exceptions to the Theorem of Coase
Core
a2
Axes
Iso-Profit Curve For Agent 2
CORE = E[1/3(1-c), 1/3(1-c)]
Iso-Profit Curve For Agent 1
a1
Exceptions to the Theorem of Coase
Core
Another example: What is the core in the
bilateral agency game?
The Nash equilibria that satisfy the
sharing rule for two agents:
/(1- ) = (F22/F11)^1/4
Neary, Hugh and Winter, Ralph, “Output Shares in Bilateral Agency Contracts”,
(1995), 66 Journal of Economic Theory 609-614
Exceptions to the Theorem of Coase
Core
• Problem: What happens if there are
more than two agents in the bilateral
agency?
• F(a ) = F(a ) = F(a ) = 0
• F(a ,a ) = F
• F(a ,a ) = F
• F(a ,a ) = F
• F(a ,a ,a ) = F
1
2
1
2
12
1
3
13
2
3
23
1
2
3
3
123
Exceptions to the Theorem of Coase
Core
The existence of Nash equilibria that
satisfy the sharing rules for three (3) or
more agents is not always guaranteed.
In some cases, subgroups of agents (subagency) will find it more “profitable” to
defect from coalitions of all the agents.
Exceptions to the Theorem of Coase
Core
F(a ,a ,a ) < (1/2)[F(a ,a ) + F(a ,a ) + F(a ,a )]
or
F < (1/2)[ F + F + F]
1
2
3
1
123
12
23
2
2
3
1
3
13
If this condition applies, the “core” is
empty.
This means F, though it may be Pareto
optimal, is unstable
123
Exceptions to the Theorem of Coase
Core
• Aivazian and Callen counterexample:
• Consider two factories F and F
emitting smoke reducing the profits of
a neighborhood laundry F.
• Suppose that the parties can negotiate
costlessly.
1
2
3
Exceptions to the Theorem of Coase
Core
•
•
•
•
•
•
•
p( F) = $3,000
p( F) = $8,000
p( F) = $24,000
p( F) = $15,000
p( F) = $31,000
p( F) = $36,000
p( F) = $40,000
1
2
3
12
13
23
123
Exceptions to the Theorem of Coase
Core
• The Coase theorem may break down when
there are more than two participants
• For example, the core of the negotiations
may be empty under the “no damages”
property rule and not empty under the
“common law nuisance” rule.
• This happens when the “third party” brings a
second externality to the problem
Exceptions to the Theorem of Coase
Core
• Note that the Pareto-optimal outcome
corresponds to the grand coalition
outcome p( F), where the externalities
are fully internalized.
123
Exceptions to the Theorem of Coase
Core
• Case 1 – Common Law Right of the
Laundry C to Sue in Nuisance
• If F has the property rights to the air,
then F and F have the incentive to
offer side-payments to F.
• However, the maximum bribe F and F
can jointly offer is only p( F) = $15,000
3
1
2
3
1
12
2
Exceptions to the Theorem of Coase
Core
• Case 1 – Common Law Right of the Laundry
C to Sue in Nuisance
• The combined maximum liability of F
and F is p( F) - p( F)
= $40,000 - $24,000 = $16,000
1
2
123
3
Exceptions to the Theorem of Coase
Core
• Case 1 – Common Law Right of the Laundry
C to Sue in Nuisance
• The “optimal joint surplus” is:
Max [p( F) - p( F), p( F)]
= Max [$16,000, $24,000] = $24,000
123
3
3
• So 1F and 2F close down and a ParetoOptimal allocation of resources results.
Exceptions to the Theorem of Coase
Core
• Case 2 – No Liability Rule
• Suppose on the other hand, that F and
F are not liable for the pollution
damages to the laundry.
F now has the incentive to offer sidepayments to F or F, and perhaps to
both, to reduce their pollution
activities.
1
2
•
3
1
2
Exceptions to the Theorem of Coase
Core
• Case 2 – No Liability Rule
• It is straightforward to show that all
potential coalitions, including the grand
coalition, are unstable when F and F
are not liable.
• Since all potential coalitions under the
“no damages rule” are unstable, the
core is empty.
1
2
Exceptions to the Theorem of Coase
Core
• Case 2 – No Liability Rule
• Suppose that the grand coalition were
to form. Consider the following
distribution of profits to F, F, and F:
• p( F) = $4,750,
• p( F) = $9,750,
• p( F) = $25,500,
adding up to p( F) = $40,000
1
1
2
3
123
2
3
Exceptions to the Theorem of Coase
Core
• Case 2 – No Liability Rule
• The two-member coalition of F and F
with
 p( F) = p( F) + p( F)

= $5,000 + $26,000

= $31,000
is preferred by F and F to the F
allocation above.
1
13
1
3
3
1
3
123
Exceptions to the Theorem of Coase
Core
• Case 2 – No Liability Rule
• Although each firm earns more than it
would by acting independently, there
are many two-member coalitions which
could block this allocation.
Exceptions to the Theorem of Coase
Core
• Case 2 – No Liability Rule
• All potential coalitions in the example
are unstable.
Exceptions to the Theorem of Coase
Core
• The Aivazian argument is that the
principle of self-interest remains in the
model
• This means individual rationality
constraints apply
• Forming a separate coalition with
another firm where both make more
profits at the expense of a third party
applies.
• Such behavior is competitive
Exceptions to the Theorem of Coase
Avoiding The
Empty Core:
Contractual Conditions
Exceptions to the Theorem of Coase
Core
• Bernholz
• Pareto Optimality can be achieved
when the core is empty by judicious
use of penalty clauses and binding
contracts.
• This is implicitly recognized in the
Neary-Winter model where if there are
three or more parties, the model does
not permit sub-contracting.
Exceptions to the Theorem of Coase
Core
• The key assumption Bernholz makes is that
once an agreement is signed it cannot be
broken without the consent of all the parties.
• Once two parties enter into an agreement the
only remaining question is whether they
make a new agreement including all three
parties.
• Since such a second agreement can make all
three better off, the grand coalition forms
and once formed it cannot come apart
• The Further Constraint: The Unanimity Rule
Exceptions to the Theorem of Coase
Core
• What does Bernholz’s argument recall?
•
•
•
•
Contract Modification
Contracts Must Be Consensual
Opportunistic or Holdup Behaviour Not Allowed
Efficient Recontracting Is Not Necessarily Allowed in
Ontario
Exceptions to the Theorem of Coase
Avoiding The
Empty Core:
Additional Parties
Exceptions to the Theorem of Coase
Core
• Mueller
• The Coase theorem will not collapse
when the number of parties increases
provided that the additional parties do
not bring additional externalities with
them.
Exceptions to the Theorem of Coase
Core
• Mueller correctly attributes the
emptiness of the core in the Aivazian
example to the existence of two
externalities rather than the existence
of three agents
• So long as there is only one externality,
the core will exist even as the number
of polluters increases.
Exceptions to the Theorem of Coase
Avoiding The
Empty Core:
Matching Externalities
Exceptions to the Theorem of Coase
Core
• Mueller’s “second” argument
• Mueller argues that the empty-core
problem is due to the attempt to
eliminate simultaneously multiple
externalities with one liability rule.
Exceptions to the Theorem of Coase
Core
• Mueller’s “third” argument
• Mueller changes the structure of the
agency game from a horizontal
(simultaneous) coalition game to a
vertical (sequential) coalition game that
contains a “Stackelberg” hierarchy
Exceptions to the Theorem of Coase
Avoiding The
Empty Core:
Vertical Agencies
Exceptions to the Theorem of Coase
Core
• Case 2 – No Liability Rule
• When F and F have the property rights,
if F’s negotiations of a bribe with F
occurs independently of F’s
negotiations with F then each
externality problem becomes
independently bilateral
• The core with respect to any given
externality is never empty.
1
2
3
1
3
2
Exceptions to the Theorem of Coase
Core
• Case 2 – No Liability Rule
• The implication is that, with multiple
externalities, particular institutional
arrangements or bargaining structures
(restrictions on the sequence of
negotiations) may be relevant for
efficient resource allocation.
Exceptions to the Theorem of Coase
Core
•
•
•
•
•
•
•
p( F) = $3,000
p( F) = $8,000
p( F) = $24,000
p( F) = $15,000
p( F) = $31,000
p( F) = $36,000
p( F) = $40,000
1
2
3
12
13
23
123
→
→
→
→
→
→
→
V(A) = 3
V(B) = 8
V(C) = 24
V(AB) = 15
V(AC) = 31
V(BC) = 36
V(ABC) = 40
Exceptions to the Theorem of Coase
Core
Exceptions to the Theorem of Coase
Core
• Case 2 – No Liability Rule
• The remaining problem?
• Mueller’s arguments undermines
the Coasean claim that specific
institutional arrangements are
irrelevant for Pareto efficiency
when transactions costs are zero.
Exceptions to the Theorem of Coase
Core
• Case 1 – Common Law Right of the Laundry
C to Sue in Nuisance
• Recalling the Aivazian example where
the laundry firm F could sue in
nuisance for damages, there were
multiple externalities but the core
existed
3
Exceptions to the Theorem of Coase
Core
• Case 1 – Common Law Right of the Laundry
C to Sue in Nuisance
• The “optimal joint surplus” was:
Max [p( F) - p( F), p( F)] = $24,000
• So F and F closed down but a Pareto123
1
3
3
2
Optimal allocation of resources still resulted.
Exceptions to the Theorem of Coase
Core
• Pareto efficiency is achieved
regardless of whether negotiations are
carried out sequentially or
simultaneously
• Once a core allocation is reached,
agents have no incentives to recontract
Exceptions to the Theorem of Coase
Avoiding The
Empty Core:
Independent
Externalities
Exceptions to the Theorem of Coase
Core
• De Bornier
• De Bornier (1986) is also bothered by
the dual externality in the Aivazian
example.
• De Bornier claims that the Aivazian
counterexample is a general
equilibrium problem
• Coase’s Theorem applies to a partial
equilibrium framework.
Exceptions to the Theorem of Coase
Core
• The problem for DeBornier stems from the fact
that in the example, if 1F and 2F merge, the
pollution effecting 3F is reduced, increasing 3F
profits
• If 1F and 3F merge, the pollution effecting 2F is
reduced, increasing 2F profits
Exceptions to the Theorem of Coase
Core
• According to Aivazian and Callen, DeBornier
assumes implicitly that there is only one
pollution source in 1F’s factory that
presumably affects both water and air
simultaneously.
• This affects De Bornier’s conclusion that a
mergers solve the legal problem in each case
Exceptions to the Theorem of Coase
Core
• “Solutions” To The Empty Core
• Pareto Optimality can be achieved when the
core is empty by judicious use of penalty
clauses and binding contracts. (Bernholz)
• The common law imposes serious “coalition
breaking” rules
• Match the externalities with the relevant agents
(Mueller)
• Apply a property rule to each externality
(Mueller)
• Create a hierarchy (Mueller and others)