1. Econ 522 Economics of Law
Dan Quint
Fall 2016
Lecture 4

2. Reminder HW1 due midnight Thursday via Learn@UW
If you want to read ahead:
Harold Demsetz, “Toward a Theory of Property Rights”

3. So far, we have… Defined efficiency
Maximizing total surplus achieved by everyone in society…
…with value measured by willingness-to-pay
Asked whether efficiency is a good normative goal for a legal system
Posner: yes, because ex ante (before we knew which part we would play), we’d all agree to efficient rules
Cooter and Ulen: yes, because even if society has other goals in mind, such as redistribution, it’s better to make the law efficient and achieve redistribution through taxes

4. So far, we have… Reviewed some basic game theory
Static games, Nash equilibrium
Motivated an interest in property law
With property rights: we’ll inevitably have some conflicts between different peoples’ rights to their property
But without property rights: tragedy of the commons, incentives to steal rather than do productive work
Up next: how should we design property rights to achieve efficient outcomes?

5. But first, an open discussion question
We asked whether efficiency is a good normative goal for a legal system
What are other plausible normative goals for a legal system?
When would you expect them to agree with, or conflict with, efficiency?

6. Property Law 5 5

7. How do we design property law to achieve efficient outcomes?6 6

8. Foxes

9. One early, “classic” property law case
Pierson v. Post (NY Supreme Court, 1805)
Lodowick Post organized a fox hunt, was chasing a fox
Jesse Pierson appeared “out of nowhere,” killed the fox and took it
Post sued to get the fox back
Lower court sided with Post; Pierson appealed to NY Supreme Court
Question: when do you own an animal?
I mention it here not because we care that much about when you establish possession of a wild animal, but because the court – both the majority and the dissenting opinion – were explicit about considering the economic effects their ruling would lead to 8 8

10. One early, “classic” property law case
Court ruled for Pierson (the one who killed the fox)
“If the first seeing, starting, or pursuing such animals… should afford the basis of actions against others for intercepting and killing them, it would prove a fertile source of quarrels and litigation”
(Also: just because an action is “uncourteous or unkind” does not make it illegal)
Dissenting opinion: a fox is a “wild and noxious beast,” and killing foxes is “meritorious and of public benefit”
Post should own the fox, in order to encourage fox hunting
That is, if the first to chase an animal owned it, there would be endless disputes and court cases; and so they favored a more “bright line” rule of ownership which would lead to fewer disagreements 9 9

11. Same tradeoff we saw earlier:
Pierson gets the fox
simpler rule (finders keepers)
easier to implement
fewer disputes
Post gets the fox
more efficient incentives
(stronger incentive to pursue animals that may be hard to catch)
Just like Fast Fish/Loose Fish vs Iron Holds The Whale
Fast Fish/Loose Fish is the simpler rule, leads to fewer disputes
Iron Holds the Whale is more complicated, but is necessary with whales where hunting them the old-fashioned way is too dangerous 10 10

12. This suggests it matters quite a bit who we award the fox to
Not just to Pierson and Post, who both want it…
…but for efficiency
And this brings us to…
The decision and dissent in Pierson v Post certainly suggest that how property law is designed will matter for efficiency
So we come back to the question: how should property law be designed to achieve this goal? 11 11

13. Coase
The decision and dissent in Pierson v Post certainly suggest that how property law is designed will matter for efficiency
So we come back to the question: how should property law be designed to achieve this goal?

14. How should property rights be allocated to achieve efficiency?
Coase’s surprising answer: it doesn’t matter
(Under certain conditions)

15. The Coase Theorem Ronald Coase (1960), “The Problem of Social Cost”
In the absence of transaction costs, if property rights are well-defined and tradable, voluntary negotiations will lead to efficiency.
It doesn’t matter how rights are allocated initially…
…because if they’re allocated inefficiently at first, they can always be sold/traded…
so the allocation will end up efficient anyway
Initial allocation does matter for distribution, though
And if there are transaction costs, may matter for efficiency too
Ronald Coase

16. Example of Coase: you have a car worth $3,000 to you, $4,000 to me
Obviously, efficient for me to own it…
…but we don’t need the law to give me the car
If I start out owning the car:
no reason for you to buy it, I end up with it  efficient
If you start out owning the car:
clear incentive for me to buy it, I end up with it  efficient
Regardless of who owns the car at first, we get to the efficient outcome
I’d rather start out with the car – so I don’t have to pay you for it
You’d rather start out with it – so you end up with more money
Efficiency doesn’t care about distribution – how much money we each end up with – just who ends up with the car at the end.
And that doesn’t depend on who starts with it.
The key: lack of transaction costs
This is easiest to illustrate with an example we’ve already seen: your car.
Since the car’s worth more to me than it is to you, we know it’s efficient for me to have the car. (Assume there are no externalities – my neighbors don’t care.)
But it turns out, in order to achieve that outcome, we don’t need a law that says I get your car – all we need is for people to be allowed to buy and sell used cars.
Why?
If I start off with the car, then great – I have the car, there’s no reason for you to buy it from me, I keep the car, and we get efficiency.
If you start off with the car, then we clearly have an incentive to come to some arrangement. Property rights have to be well-defined – it has to be clear that it’s your car, and you have to be allowed to sell it to me. But as long as that’s the case, we should be able to reach some bargain – I give you $3,500, or maybe a bit more, or maybe a bit less – and you give me the car. So I end up with the car, which is efficient.
The point is, regardless of who starts off with the car, I’m going to end up with it.
I’d rather I start with the car – that way, I don’t have to pay you anything.
You’d rather you start with the car – that way, you end up with a bunch of my money.
But for efficiency, it doesn’t matter who starts with the car - we’ll achieve efficiency (me having the car) either way.
The key here is the absence of transaction costs.
Basically, there can’t be any impediments to us reaching a private agreement
If every time someone sold a used car, the buyer had to pay a huge tax to the government, the Coase theorem would fail
We saw a few examples earlier of forces that lead to inefficiency – barriers to trade, taxes. These can be thought of as transaction costs.
Next lecture, we’ll discuss what some sources of transaction costs are; for now, just think of them as anything that gets in the way of us trading among ourselves.

17. Another example: you want to have a party in the house next door to mine
If it’s efficient for you to have the party…
Your benefit from having the party is greater than my benefit from a good night’s sleep
If you start out with the right to have the party, no problem
If I start out with the right to quiet, you can pay me for the right to have the party
If it’s efficient for you not to have the party…
Good night sleep is worth more to me
If I have right to silence, no problem
If you have right to party, I can pay you not to have it
The point: either way, we achieve efficiency
If it’s efficient to have the party, you have the party
If it’s efficient not to, you don’t
Regardless of who started off with the right
The Coase theorem sounds pretty obvious when it comes to objects. If you own something, but it’s worth more to me, and there’s nothing to stop you from selling it to me, I guess you’ll end up selling it to me. Obviously.
What Coase did, though, was apply this to rights, and situations with externalities, as well.
I have an apartment, and you live next door, and you want to have a party on Saturday
I hate noise, and don’t want you to.
Should you be allowed to have the party?
The point of Coase: think of the right to have the party (or to prevent it) as just another object
If it’s efficient for you to have the party, that means the party is worth more to you and your guests than a good night’s sleep is worth to me
Which means the “party rights” are worth more to you than they are to me
If you start out with them, great
If I start out with them – if the law gives me the power to prevent you from making noise – you can buy the rights from me. That is, you can pay me to allow you to have the party.
And if it really is efficient for you to have the party, you and your guests can come up with enough money to buy me off, and still be better off yourselves.
What if sleep is worth more to me than the party is to you?
That means it’s not efficient to have the party.
If I start out with the right to peace and quiet, we don’t need to do anything
But if you start out with the right to have a party, I can bribe you not to.
Again, for distribution, who starts off with the rights matters – since they’re worth something, we’d both rather have them. But who starts off with them doesn’t matter for efficiency – we’ll get to efficiency either way

18. Real-world example from three years ago
Another example:
Football game day parking in student rentals
Suppose city outlawed leases that force residents to move their car
Instead of signing lease for $850/month, sign lease for $1,000/month, with agreement you get $150 back if you move your car every game day
source:

19. The conditions for this to hold
Property rights have to be well-defined…
It must be clear on who has what rights to start with, so we know the starting point for negotiations
…and tradable…
We need to be allowed to sell/transfer/reallocate rights if we want
…and there can’t be transaction costs
It can’t be difficult or costly for us to buy/sell the right
So, the Coase Theorem:
In the absence of transaction costs,
if property rights are well-defined and tradable,
voluntary negotiations will lead to efficiency.

20. Coase’s example: a rancher and a farmer
Coase doesn’t actually write about neighbors and parties - he starts with a different example
Suppose that on adjacent tracts of land, there is a cattle rancher and a farmer
The rancher has cows, the farmer grows some crop – say, corn
And on occasion, the rancher’s cattle will occasionally stray onto the farmer’s land and eat some of the crops
So we need a rule for who’s responsible for the damage when that happens

21. Rancher’s versus farmer’s rights
English common law: “closed range” or “fencing-in” (or “farmer’s rights”)
Ranchers have responsibility to control their cattle
Rancher must pay for any damage done by his herd
Much of the U.S. at various times: “open range” or “fencing-out” (or “rancher’s rights”)
Rancher can let his cattle roam free
Not liable for damage they do to farmer’s crops
(unless farmer had a good fence and they broke through anyway)
Which rule is more efficient?
There are two obvious candidates for what the law could be: either the rancher is responsible for the damage his cattle did, or he isn’t

22. Open range versus closed range
First, let’s consider what happens under an open range law – that is, when the rancher is not liable for damage done by his herd
When the rancher is deciding on the size of his herd, he weighs only the private costs and benefits, ignoring the incremental damage that a larger herd would do to his neighbor’s crops – that is, ignoring the externality he imposes
So on the margin, this may lead him to a cattle herd that’s inefficiently large
In addition, since he isn’t harmed by the damage done by his herd, he has no incentive to build a fence or to do anything else to rein in his herd
But the farmer, faced with the prospect of damage, has a clear incentive to take any steps he can to reduce the damage – such as
building a fence around his crops to keep out wandering cattle
planting less
planting less along the boundary between the two tracts of land
or planting crops that cows don’t like along the boundary
or any other steps that might also be cheaper than the damage done.
Next, consider what happens under a closed range law – when the rancher is liable for any damage done by his herd
Now the farmer has no reason to build a fence, or to take any other action
When the rancher is deciding how big a herd to keep, he will consider the incremental damage done to his neighbor, since he has to pay for the damage; and he will consider actions that he can take to restrain his herd, like fencing in the grazing land, if that’s cheaper than paying for the damage

23. Coase: either law will lead to efficiency
If it’s cheaper for the farmer to protect his crops than for the rancher to control his herd…
Under open range law, that’s what he’ll do
Under closed range law, rancher can pay farmer to build fence
If smaller herd is more efficient, farmer can pay rancher to keep fewer cattle
Coase:
Whatever is the efficient combination of cattle, crops, fences, etc.…
…the rancher and farmer will negotiate to that efficient outcome, regardless of which law is in place…
…as long as the rights are well-defined and tradable and there are no transaction costs
Coase, however, comes along, and says it doesn’t matter which law is in place – either one will lead to the same, efficient outcome
If it’s cheaper for the farmer to fence in his crops, rather than the rancher fencing in his herd…
Under an open range law, that will happen automatically
Under a closed range law, rather than fencing in his herd, the rancher will pay the farmer to build a fence around his crops
If it’s efficient for the rancher to keep a smaller herd, the farmer can pay the rancher to do so
Coase’s conclusion: whatever is the most efficient combination of cattle, crops, fences, and so on, is exactly what will happen, because the rancher and farmer will negotiate to that outcome to save money
Just as long as his assumptions are satisfied – property rights are well-defined and tradable, and there are no transaction costs

24. Note that there’s no sense of “blame” here
Pigovian tax (Arthur Pigou)
Penalize firms for causing negative externalities
Requires us to “blame” one party
Coase: doesn’t matter who is “causing” the harm
“It is true that there would be no crop damage without the cattle.
It is equally true that there would be no crop damage without the crops.”
Coase isn’t worried about “justice”, just efficiency
Doesn’t matter if a polluter is actually charged for polluting…
…or is allowed to pollute, but could be bribed to not pollute
Either way, without transaction costs, we’ll end up getting the efficient amount of pollution!

25. Rancher and farmer: numerical example
Three possibilities:
Rancher builds fence around herd… costs $400
Farmer builds fence around crops… costs $200
Do nothing, live with damage… costs nothing
If expected crop damage = $100
Open range: farmer lives with damage rather than building fence
Closed range: rancher pays for damage rather than fence
If expected crop damage = $500
Open range: farmer builds fence – efficient
Coase: closed range: rancher pays farmer to build fence
So efficient outcome under either rule
To be more specific…
Suppose there are three things that could be done about the problem:
The rancher could build a fence to restrain his herd – suppose this costs $400
The farmer could build a fence to protect his crops – suppose this costs $200
Finally, they could both just do nothing, and live with the damage
Now, if the damage the cattle will do is less than $200, there’s no reason to do anything
Suppose the damage is only $100
it’s inefficient to build a fence – it costs more than the problem it solves
in a rancher’s rights world – where the rancher is not liable for damage done by his herd – the farmer won’t choose to build a fence, he’ll just eat the $100 loss
in a farmer’s rights world – where the rancher is liable – he’ll just live with paying the farmer $100 to reimburse him for the damage
On the other hand, suppose the damage the cattle will do is more than $200
suppose it’s $500
then the efficient thing is for the farmer to build a fence
in a rancher’s-rights world, this will happen “automatically” – the farmer would rather build a $200 fence than suffer $500 of unreimbursed damages
the point of Coase: in a farmer’s-rights world, this is also what will happen – because the rancher will pay the farmer to build a fence
that is, rather than face paying $500 for the damage done, and rather than spend $400 to build his own fence, he will offer the farmer some smaller amount – say, $300 – to put up a fence
and the farmer will prefer that to doing nothing

26. Other examples from Coase
Lots of examples from case law
a building that blocked air currents from turning a windmill
a building which cast a shadow over the swimming pool and sunbathing area of a hotel next door
a doctor next door to a confectioner
a chemical manufacturer
a house whose chimney no longer worked well after the neighbors rebuilt their house to be taller
In each case, regardless of who is initially held liable, the parties can negotiate with each other and take whichever remedy is cheapest to fix (or endure) the situation
Coase gives a number of examples of specific cases in nuisance law, and repeats the point that, regardless of who is initially held responsible for the harm, negotiation and trade will lead to efficiency from any starting point
Some of his other examples:
An early English case of a building which was built in such a way that it blocked air currents from turning a windmill
A building in Florida which cast a shadow over the swimming pool and sunbathing areas of a nearby hotel
A doctor whose office was next door to a confectioner, who built a new examination room and found that the vibration from the confectionery’s machinery prevented him from listening to his patients’ chests through a stethoscope in that room
A chemical manufacturer whose fumes interacted with a weaver’s products while they were drying after bleaching
A house whose chimney no longer worked well after its neighbors rebuilt their house to be taller
In each example, he argues that, regardless of who is held to be liable, the parties can negotiate with each other and take whatever remedy is cheapest to fix (or endure) the situation.

27. Quoting from Coase (p. 13):
Judges have to decide on legal liability but this should not confuse economists about the nature of the economic problem involved.
In the case of the cattle and the crops, it is true that there would be no crop damage without the cattle. It is equally true that there would be no crop damage without the crops.
The doctor’s work would not have been disturbed if the confectioner had not worked his machinery; but the machinery would have disturbed no one if the doctor had not set up his consulting room in that particular place…
This is an important point – Coase points out, we shouldn’t think of the problem as, “Should the rancher be allowed to harm the farmer?”, since that begs the question. Instead, we should ask the question, “Either the rancher harms the farmer, or the farmer harms the rancher; which of these situations is the more efficient?”

28. Quoting from Coase (p. 13):
If we are to discuss the problem in terms of causation, both parties cause the damage.
If we are to attain an optimum allocation of resources, it is therefore desirable that both parties should take the harmful effects into account when deciding on their course of action.
It is one of the beauties of a smoothly operating pricing system that… the fall in the value of production due to the harmful effect would be a cost for both parties.
That is, both parties perceive the cost of the externality, at least as an opportunity cost.

29. What does Coase mean by “a cost for both parties”?
If the cheapest alternative is for the farmer to build a fence for $200…
The cost to build a fence is $200
But the cost to not build a fence is more than $200 – since under a closed-range law, the farmer could ask the rancher for more than $200 to build the fence
“Opportunity cost”
This last part is a little subtle. But go back to our rancher-farmer example.
The rancher’s cattle are doing $500 worth of damage, and the cheapest way to fix it is for the farmer to build a fence for $200
consider the farmer’s-rights world
the farmer doesn’t have to build a fence – the rancher will have to build his own fence, or pay for the damage
but even though he doesn’t have to build a fence, the farmer perceives the cost of not building the fence as higher than the cost of building it
this is because he faces an opportunity cost
the cost of building the fence is $200
the cost of not building the fence is the foregone opportunity to get the rancher to pay him MORE THAN $200 to build it
If I’m causing $100 of damage to my neighbor but I could prevent it for $10, a “smoothly operating pricing system” causes me to view the cost of the externality as $100 in opportunity cost – since I could presumably get my neighbor to pay me that much money to prevent the damage.

30. So, summing up… Coase Theorem: In the absence of transaction costs,
if property rights are well-defined and tradeable,
voluntary negotiations will lead to efficiency.
The initial allocation of property rights therefore does not matter for achieving efficiency…
…provided there are no transaction costs
(But if there are transaction costs, then the initial allocation can matter for efficiency…
…and it will always matter for distribution)
So that’s the Coase Theorem
Of course, the limitations we mentioned still hold:
First, Coase says that the initial allocation of rights (or liability) does not matter for efficiency – but as we said, it does matter for distribution
And second, all of this only works in the absence of any transaction costs – which may not be the case in the real world
(we’ll come back to transaction costs in a bit)

31. Back to Foxes

32. Doesn’t Coase make Pierson v Post irrelevant?
Coase seems to say: for efficiency, it doesn’t matter who starts off with the right to the fox
If Post values it more, he can buy it from Pierson, or vice versa
Seems to imply: one rule is just as good as the other, as long as we all know what the rule is
So why does Pierson v Post matter?
Transaction costs!
Majority: if Post gets the fox back, “it would prove a fertile course of quarrels and litigation” – the ensuing lawsuits would be costly
Dissent: killing foxes is a good thing (externality), so lots of people benefit – so hard to get efficient amount of fox hunting through bargaining
We started today’s lecture talking about Pierson v Post, the fox hunt case
Both the majority and the dissenting opinion seemed to imply the ruling mattered for efficiency
Majority wanted to reduce the number of fox cases that ended up in court
Dissent wanted to get more people to hunt foxes
But we just saw the Coase theorem, which says that the initial allocation of rights shouldn’t matter for efficiency
As long as we all know what the rule is, and can bargain around it, any rule is just as good as another
So why doesn’t Coase make the actual ruling irrelevant?
The Coase Theorem required a complete absence of transaction costs
But in the real world, there sometimes are transaction costs
The situation the Pierson court was concerned with – lots of lawsuits in the future – is exactly a transaction cost
If we allow ownership based on “I saw the fox first”, people will constantly be suing each other…
…and those lawsuits waste time and money!
The situation the dissent was concerned with – not enough foxes being hunted – is also related to transaction costs
They write that killing foxes is of public benefit – that it has an externality
This means that lots of people are affected by someone’s decision to hunt foxes
But as we’ll discuss Wednesday, bargaining is very difficult – and/or costly – when lots of people are involved
So it may be very hard to achieve the efficient level of fox hunting through negotiations!
Coase says, in situations with no transaction costs, the initial allocation of rights doesn’t affect efficiency
But lots of real-world situations do indeed have transaction costs

33. Transaction costs
Coase: “in the absence of transaction costs, if property rights are well-defined and tradable, voluntary negotiations will lead to efficiency.”
This suggests that if there are transaction costs, voluntary negotiations may not lead to efficiency
Car example (yet again)
If transactions are costly, we may not trade
And if we do trade, we incur that cost
Recall our statement of the Coase Theorem:
In the absence of transaction costs, if property rights are well-defined and tradeable, voluntary negotiations will lead to efficiency, and the initial allocation of property rights won’t matter for efficiency.
But this also suggests the converse might be true:
when private negotiations are not costless, or transaction costs are not zero, that we may not get efficiency, and initial allocations may matter.
When there are transaction costs, we can get inefficiencies for two reasons:
first, when transaction costs are high, they will prevent certain trades that would have been beneficial
if your car is worth $3,000 to you and $4,000 to you, but it would cost us $2,000 to find each other and transact, you’ll keep the car
and second, any resources actually spent overcoming the transaction costs are, in a sense, wasted
if it costs us $500 to find each other and transact, we’ll still do it, but we will have lost that $500

34. Quoting Coase…
“If market transactions were costless, all that matters (questions of equity apart) is that the rights of the various parties should be well-defined and the results of legal actions easy to forecast.
But… the situation is quite different when market transactions are so costly as to make it difficult to change the arrangement of rights established by the law.
In such cases, the courts directly influence economic activity.
…Even when it is possible to change the legal delimitation of rights through market transactions, it is obviously desirable to reduce the need for such transactions and thus reduce the employment of resources in carrying them out.

35. We can see the Coase Theorem as either a positive or negative result
“In the absence of transaction costs, if property rights are well-defined and tradable, voluntary negotiations will lead to efficiency.”
We can read this as…
“As long as transaction costs aren’t a big deal, we’ll get efficiency”
Or as, “we’ll only get efficiency automatically if there are no transaction costs”
Coase also gives two examples of institutions that may emerge in response to high transaction costs:
Firms
Government regulation
Coase offers two examples of institutions that may emerge in response to high transaction costs: firms, and government regulation
Suppose it is very difficult or costly for the rancher and the farmer to come to an agreement among themselves.
One solution is for the ranch and the farmland to be both be purchased and operated by the same firm.
Then the firm balances the costs and benefits of both activities, and makes decisions (what fence to build, how big a herd to raise) to maximize the total value of production
The second example, government regulation, is the same idea, since he imagines the government as a sort of “super-firm” which considers the costs and benefits of each activity to everyone.

36. Many externalities can be thought of as missing property rights
Overfishing in communal lake?
It’s because property rights over those fish aren’t well-defined
Firm polluting too much?
It’s because property rights over clean air aren’t well-defined
So one solution…
Make property rights complete enough to cover “everything,” and tradable, and use the law to minimize transaction costs…
…Then Coase kicks in and we get efficiency! (Booya!)
Why not do this? Costs.

37. Relating Coase to general equilibrium/ first welfare theorem
given prices, consumers maximize utility
given prices, firms maximize profits
prices are such that all markets clear
First Welfare Theorem: general equilibrium is efficient
But not when there are externalities, or “missing markets”
Allowing the consumer to negotiate with the firm is like introducing a “missing market” in air rights
Some of you may remember General Equilibrium Theory from 301
General Equilibrium is when everyone does whatever is best for them, given the prices they see
consumers maximize utility, firms maximize profits, etc.
and prices are such that markets all clear
and the First Welfare Theorem states that General Equilibrium is always efficient.
The first time I taught this class, on the second day of class, I solved an example of this
a setting with two consumers
one of them is a hops farmer – he had lots of hops, he ate hops, and liked beer too
the other was a brewer – he didn’t own any hops, but he had a technology for turning hops into beer
The first thing we did was to find the general equilibrium
Given a set of prices for hops and beer, we could work out how much hops and how much beer the farmer would demand
Given a set of prices, we could also work out how much beer the brewery would produce to maximize profits
And then we found the set of prices such that markets cleared
And we showed, as expected, that the result was efficient

38. Relating Coase to general equilibrium/ first welfare theorem
given prices, consumers maximize utility
given prices, firms maximize profits
prices are such that all markets clear
First Welfare Theorem: general equilibrium is efficient
But not when there are externalities, or “missing markets”
Allowing the consumer to negotiate with the firm is like introducing a “missing market” in air rights
Next, we worried about externalities
Suppose the farmer hates the smell emanating from the brewery
But there are no environmental controls – the brewery can do whatever it wants
Because the externality, the general equilibrium is now inefficient
the farmer would like the brewery to brew less beer, so the smell is weaker
but he has no control over market prices
But then comes Coase, and he says that the farmer could just negotiate with the brewer
Farmer says look, how about instead of paying you $9 per six-pack for this many beers, I’ll pay you a little more for a little fewer
That way, you can produce less beer, but still earn higher profit
So they reach an agreement, and it’s efficient
And the point of Coase is that, whoever starts off with the “air rights,” we’ll get to efficiency
If the brewery starts off with the right to pollute, the farmer can negotiate a reduction in pollution
If the farmer starts off with the right to breathe clean air, the brewery can go to him and negotiate rights to pollute some
And in either case, they’ll reach an efficient outcome
They’ll be different outcomes – if the farmer starts off with the right, he’ll end up richer, and able to consume more, than if the brewery does – but in either case, the outcome will be efficient.
So another way to think about Coase is to say that we can overcome externality problems by expanding property rights to include whatever is causing the externality
Problem with an externality is it’s something that enters your utility function, but there’s no market for it
By creating a market for “air rights” – that is, by turning “air rights” into a tradeable good – we can use the pricing system to get to efficiency, regardless of who starts off owning these rights.

39. Nice interpretation/example from the paper we’re talking about next
“There are two striking implications… that are true in a world of zero transaction costs.
The output mix that results when the exchange of property rights is allowed is efficient,
and the mix is independent of who is assigned ownership.
For example, the the efficient mix of civilians and military will result from transferable ownership no matter whether taxpayers must hire military volunteers or whether draftees must pay taxpayers to be excused from service.
For taxpayers will hire only those military (under the “buy-him-in” property right system) who would not pay to be exempted (under the “let-him-buy-his-way-out” system).”
The Coase Theorem relies heavily on peoples’ ability to bargain with each other
So let’s talk some more about…
Harold Demsetz (1967), Toward A Theory of Property Rights 38 38

40. That’s it for today HW1 due (online submission) midnight Thursday
For Wednesday
Demsetz, “Toward a Theory of Property Rights”