Question

1. A kebap shop and a fancy café are adjoin. Due to the kebap shop cause too much smoke and smell, the café loses costomers.

There are number of costomers and profit assoicated with them are given below. Profit of café decreses as the number of costomers of Kebep shop increases. Depending on these data, can Coase Theorem find a solution for this externalities problem? Why?

Kebap shop                                                   The Café

Number of costomer     Profit                                  Profit                   Total

0                                          0                                          4000                     4000

100                                      3000                                   2500                     5500

200                                      5000                                   1500                     6500

300                                      6000                                   1000                     7000

Answer 1

According to the Coase theorem, two private parties will be able to bargain with each other and find an efficient solution to an externality problem.

In this scenario, the profit of cafe decreases as the number of customers of Kebep shop increases. And as the number of costomers of Kebab shop increases, the profit of Kebab shop increases. Thus the cafe will provide compensation to the Kebab shop to keep its number of customers low. This is possible only if the compensation provided by the cafe to the Kebab shop is more than the gain in profit of Kebab shop from additional customers.

Let us see if it is possible

Customers	Increase in profit to Kebab shop	Decrease in profit to Cafe
0	0	0
100	3000	1500 (4000 - 2500)
200	2000 (5000- 3000)	1000 (2500 - 1500)
300	1000 (6000- 5000)	500 (1500 - 1000)

Since throughout the increase in profit to Kebab shop is more than the decrease in profit to Cafe, the Cafe will not be able to provide enough compensation to the Kebab shop to reach a Coase solution. The Coase theorem fails to find a solution to this externalities problem.