Coase Theorem

Building the graph Producer creates  output Creates benefits “marginal” benefits (diminishing)  pollution

Building the graph Producer creates  output Creates benefits “marginal” benefits (diminishing)  pollution Total Benefit to Company

Building the graph, cont’d With  pollution Community experiences  Costs clean up health care lost tourism Total Costs to Community

“Optimal” solution (max social benefit) without actual transactions ?? Total Benefit to Company Total Costs to Community

“Optimal” solution (max social benefit) without actual transactions 100 units pollution  output/pollution  benefits ‹  Costs to community Net Social Gain output producing 60 units of pollution MB company = MC community “Optimal” amount of pollution “Equitable” to Both parties

Coase Theorem says same “optimal” outcome obtained via market transactions Both parties benefit, thus, both agree Case 1 Community owns “right” to determine how much pollution is permissible Begin with zero pollution Company would like to produce output & gain benefit. But, creates Pollution “optimal” 60 reached via Market mechanism

What has been achieved? Community has 1.pollution costing $6000 (C) 2.$12000 new income (B+C) 3.Net Gain $6000 Company has 1.Made pmts of $12000 (B+C) 2.Gained benefits of $21000 (A+B+C) 3.Net profit of $9000 (A) C = $6000 B = $6000 A = $9000 Same “Optimal” result obtained via Market

Case 2 Company owns “right” to determine how much pollution they make Begin with output that creates maximum benefits of $25,000 (A+B+C+D) and creating 100 units pollution Community incurring costs of $17,000 (C+D+E+F) A = $9000 B = $6000 C = $6000 D =$4000 E = $4000 F =$3000

Case 2 Company owns “right”, Cont’d Community wants to reduce pollution Offers to make pmt of $200 unit to cutback output Both parties benefit, thus, both agree

What has been achieved? For community Community has 1.Eliminated $11,000 in pollution costs (D+E+F) 2.Made pmts of $8,000 (D+E) 3.Left with pollution costs of $6,000 4.Total Outlay (to get rid of all pollution) $14,000 (C+D+E) vs,$17,000 F =$3000 E = $4000 D =$4000 C = $6000

What has been achieved? For the company F =$3000 A = $9000 C = $6000 B = $6000 E = $4000 D =$4000 Company has 1.Reduced output & pollution, giving up benefit of $4,000 (D) 2.Received pmts of $8,000 (D+E) 3.Retains existing benefit of $21,000 (A+B+C) 4.Existing benefit plus pmts = Total Benefit $29,000 (A+B+C+D+E)

Company Holds Rights CommunityCompany Beginning position $17,000Pollution costs$25,000Benefits 8,000Pmts made$8,000Pmts rec’d 11,000  Pollution costs 4,000  Lost benefits from  output & pollution 6,000Remain Costs21,000 Remain benefits Ending position$14,000 Total pmts made & remain costs $29,000 Total pmts rec’d & remain benefit $3,000Improvement$4,000Improvement Change in Pollution 40 unit Reduction (60 units remain) Text p53

Community Holds Rights CommunityCompany Begin position 0 unitsPollution$0Benefits $12,000Pmt rec’d$12,000Pmt made 6,000Pollution permitted 21,000Benefit from new output & pollution End position$6,000 Remain after pmts used to clean up pollution $9,000Remain benefit after pmts Improvement$6,000$9,000 Change in pollution 0 units (60 units created, but cleaned up)

Coase Theorem Assumptions: Given distribution of wealth and income Complete Information No Transaction Costs Clear Property Rights Problems: Wealth Effect Free-Rider Hold-out Cost to Obtain Information Negotiation Costs Default Ownership ?? All this in text book

“ Optimal” solution for both parties without actual output that emits 90 units of effluent

Coase Theorem says same “optimal” outcome obtained via market transactions Case 2 Company owns “right” to determine how much pollution they make Begin with maximizing benefits of $25000 (A+B+C+D) and creating 100 units pollution Community incurring costs of $17000 (C+D+E+F)