Overview of coase theorem
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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
“optimal” @ output
producing 60 units
of pollution
MBcompany = MCcommunity
“Optimal” amount
of pollution
“Equitable” to
Coase Theorem says same “optimal”
outcome obtained via market transactions
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
Both parties benefit,
thus, both agree
“optimal”
60 reached
via Market
mechanism
Community has
1. pollution
costing
$6000 (C)
2.
3.
What has been achieved?
$12000
new income
(B+C)
Same “Optimal”
result obtained
via Market
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)
A = $9000
B = $6000
C = $6000
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
F=$3000
E = $4000
B = $6000
C = $6000
D=$4000
Case 2 Company owns “right”,
Community
wants to
reduce
pollution
Offers to
make pmt
of $200
unit to
cutback
output
Cont’d
Both parties benefit,
thus, both agree
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
What has been achieved?
For community
F=$3000
get rid of
all pollution)
E = $4000
$14,000
(C+D+E)
vs,$17,000
C = $6000
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)
What has been achieved?
For the company
A = $9000
F=$3000
E = $4000
B = $6000
C = $6000
D=$4000
Company Holds Rights
Community
Beginning
position
$17,000 Pollution costs
8,000 Pmts made
11,000 ⇓ Pollution
costs
6,000 Remain Costs
Ending position
$14,000 Total pmts made
& remain costs
$3,000 Improvement
Change in
Pollution
40 unit Reduction
Company
Text
p53
$25,000 Benefits
$8,000 Pmts rec’d
4,000 ⇓ Lost benefits
from ⇓ output &
pollution
21,000 Remain benefits
$29,000 Total pmts rec’d &
remain benefit
$4,000 Improvement
(60 units remain)
Community Holds Rights
Community
Begin
position
0 units Pollution
$12,000 Pmt rec’d
6,000 Pollution
permitted
Company
$0 Benefits
$12,000 Pmt made
21,000 Benefit from
new output &
pollution
End position
$6,000 Remain after
$9,000 Remain benefit
after pmts
Improvement
$6,000
$9,000
Change in
pollution
pmts used to
clean up
pollution
0 units
(60 units created, but cleaned up)
Coase Theorem
Assumptions:
Problems:
• Given distribution of
wealth and income
• Complete
Information
• No Transaction
Costs
• Clear Property
Rights
•
•
•
•
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 transactions
@ 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)
