Overview of coase theorem

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 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 pollution costing $6000 (C) What has been achieved? $12000 new income (B+C) Same “Optimal” result obtained via Market Net Gain $6000 Company has Made pmts of $12000 (B+C) Gained benefits of $21000 (A+B+C) Net profit of $9000 (A) A = $9000 B = $6000 C = $6000 Case 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 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 Eliminated $11,000 in pollution costs (D+E+F) Made pmts of $8,000 (D+E) Left with pollution costs of $6,000 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 Reduced output & pollution, giving up benefit of $4,000 (D) Received pmts of $8,000 (D+E) Retains existing benefit of $21,000 (A+B+C) 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 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 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 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) [...]... 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... 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)