Coase TheoremFriedman Eric Rasmusen, erasmuseIndiana'edu

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Coase Theorem-Friedman Eric Rasmusen,
erasmuse_at_Indiana.edu

G604, lecture 6, February 5, 2003

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Coase Theorem Example
A steel mills pollution reduces resort profit
by 200,000 unless 100,000 is paid to control
pollution. There is a real externality of
200,000. The Pigouvian tax would be to charge
the steel mill 200,000 if it pollutes. It would
then choose to control the pollution instead.
Coase insight Suppose the resort could
switch to timber, earning 50,000 less. Then the
Pigouvian tax is inefficient. Or, just let
the steel mill and the resort negotiate with each
other. If the property right who has the legal
right to decide pollution is clear, the outcome
will be efficient.
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The Coase Theorem
If transaction costs are zero, then any initial
allocation of property rights leads to an
efficient outcome. (Friedmans
statement) What is interesting is to figure out
the implications of transaction costs. A
function of law is to minimize transaction costs.
Coase, Ronald H., "The Problem of Social Cost,"
Journal of Law and Economics, October 1960,
31-44 http//www.daviddfriedman.com/laws_order
/
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The Train Sparks Example
A railroad chooses whether to install a spark
arrester or not. 100 farmers each choose whether
to plant clover or not. Clover does not burn.
Possible Rules (who decides? who pays?) 1.
Railroad property right. The railroad can throw
sparks if it so desires. 2. Farmer property
right. Any one farmer can stop the railroad from
throwing sparks. 3. Farmer liability right.
The railroad can throw sparks if it pays the
farmers for any damage that results. 4.
Railroad liability right. Any one farmer can stop
the railroad from throwing sparks, but he must
pay the railroads cost of installing a spark
arrester.
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Property and Liability Rules
If you are protected by a property rule, you can
go to court and get an injunction to stop
someone from doing X. (court of common
law) Examples Patent infringement, someone
building a house on your land, someone stealing
your car If you are protected by a liability
rule, you can go to court and get damages from
someone who has done X. (court of
equity) Examples tort suits for personal
injury, damages for breach of contract
Calabresi, Guido Melamed, Douglas, "Property
Rules, Liability rules and Inalienability One
View of the Cathedral", 85 Harvard Law Review
1089 (1972).