6. Absence of Property Rights The Coase Theorem Ronald Coase ( ), Nobel Laureate, Ronald H. Coase: On Economics ECO324 Chapter 3—Modeling Market Failure

Property Rights Valid claims to a good or resource that permit the use and transfer of ownership through sale For environmental goods, it’s unclear who “owns” rights Economics says it’s the absence of rights that matters, not who possesses them 2

Coase Theorem Proper assignment of property rights, even if externalities are present, will allow bargaining between parties such that efficient solution results, regardless of who holds rights – Assumes costless transactions – Assumes damages are accessible and measurable 3

The Coase Theorem: An Example Dick owns a dog named Spot. Negative externality: Spot’s barking disturbs Jane, Dick’s neighbor. The socially efficient outcome maximizes Dick’s + Jane’s well-being. – If Dick values having Spot more than Jane values peace & quiet, the dog should stay. Otherwise, the dog should go. Coase theorem: The private market will reach the efficient outcome on its own… 4 See Spot bark.

The Coase Theorem: An Example CASE 1: Dick has the right to keep Spot (Jane needs to pay Dick to get rid of Spot). Benefit to Dick of having Spot = $500 Cost to Jane of Spot’s barking = $800 Socially efficient outcome: Spot goes bye-bye. Private outcome: Jane pays Dick $600 to get rid of Spot, both Jane and Dick are better off. Private outcome = efficient outcome 5

The Coase Theorem: An Example CASE 2: Dick has the right to keep Spot (Jane needs to pay Dick to get rid of Spot). Benefit to Dick of having Spot = $1000 Cost to Jane of Spot’s barking = $800 Socially efficient outcome: See Spot stay. Private outcome: Jane not willing to pay more than $800, Dick not willing to accept less than $1000, so Spot stays. Private outcome = efficient outcome 6

The Coase Theorem: An Example CASE 3: Jane has the legal right to peace & quiet (Dick needs to pay Jane to keep Spot). Benefit to Dick of having Spot = $500 Cost to Jane of Spot’s barking = $800 Socially efficient outcome: Spot goes bye-bye. Private outcome: Dick not willing to pay more than $500, Jane not willing to accept less than $800, so Spot goes bye-bye. Private outcome = efficient outcome 7

The Coase Theorem: An Example CASE 4: Jane has the legal right to peace & quiet (Dick needs to pay Jane to keep Spot). Benefit to Dick of having Spot = $1000 Cost to Jane of Spot’s barking = $800 Socially efficient outcome: Spot stays. Private outcome: Dick pays Jane $900 to keep Spot, both Jane and Dick are better off. Private outcome = efficient outcome 8

The private market achieves the efficient outcome regardless of the initial distribution of rights. 9

Solution to Externalities Government Intervention Internalize externality by: – Assigning property rights, OR – Setting policy prescription, such as: Set standards on pollution allowed Tax polluter (= MEC at Q E ) Establish a market and price for pollution 10