COASE THEOREM:

1
COASE THEOREM

• 'the proposition that if parties can bargain
  without cost over the allocation of resources,
  they can solve the problem of externalities on
  their own' (Mankiw, p. 210)
• 'When transaction costs are zero the allocation
  of resources is independent of the distribution
  of property rights'

2
COASE THEOREM

• implication that when bargaining is costless
  resources will end up in their highest valued use
• Outcome not one of zero pollution
• Bargaining Costs

3
At J MBmill Price MC 0 MCangl
KH gt MBmill
At L Price - MCMill ES MCAngl ES

At J Price MCmill HR MCangl
KR gt HR
At M Price - MC NS MCAngl TS lt
NS
A
N
G
K
K
E
G
T
H
H
F
R
S
S
F
L
J
J
M
Q
B
4
Economic Principle No. 7"Governments can
sometimes improve market outcomes"

• Transaction costs
• "Costs that parties incur in the process of
  agreeing and following through a bargain"
  (Mankiw, p. 211)
• Sources of transaction costs
• free riding
• strategic behaviour
• Government mimics ideal market solution i.e.
  public solutions

5
PUBLIC SOLUTIONS TO EXTERNALITIES

• Regulation
• set of rules governing behaviour
• command and control
• e.g. emission standard
• Pigovian Taxes
• increase polluters mc to mc to society
• bring market equilibrium to social optimum
• Emission Charges
• effectively same as Pigovian tax

6
POLLUTION PERMITS

• grant right to generate specified level of
  pollution i.e. optimum level
• multiple polluters
• tradable permits
• Market for Pollution Rights
• Mankiw Figure 10.5
• demand curve for pollution rights
• MB of pollution rights marg. profit of
  pollution
• Mprofit MRevenue - MC
• see Supplement 1 and EPA web-link

7
PUBLIC SOLUTIONS

• get 'best' outcome when they make agents
  internalise the externality i.e. complete the
  market

8
More Missing Markets

• Externalities arise from missing markets
• Internalise by completing market
• (i) private solutions where TCs are low
• (ii) public solutions where TCs are high
• Conditions for markets to work well

9
Collective Property Rights

• Over utilisation
• Common grazing, fish stocks
• Lack of husbanding/investment

10
Common Resources

• Non-excludable - dont reveal value
• Rivalness - conumption has opportunity cost
• Over-utilisation

11
Public Goods

• Non-excludable - dont reveal value
• Non-rival - use has zero opportunity cost
• Under-production by market
• Typically provided by government
• e.g. defence, law and order, information
• Not all goods supplied by govt. are pure public
  goods - Merit goods

12
Merit goods

• Market Consumption too low
• Large external benefit
• e. g. health, education

13
Role for Government

• Externalities
• Low TCs - encourage private solutions
• - specify property rights
• High TCs - public solution
• - Pigovian taxes, standards,
  permits
• Merit Goods
• Public subsidy - MSBgt MB
• - public provision
• Public Goods
• Non-excludability - free rider
• Non-rival (zero opp. Cost) - p MC 0
• Market under-provides