Question

Durian is a fruit from Southeast Asia. It is, by many reports, absolutely delicious. Unfortunately, it also stinks. It fact, it stinks badly enough that some municipalities in Thailand have banned its consumption on public transportation. Draw a graph that illustrates the probable externality associated with the market for durian. Now, recall the Coase theorem. Do you think this externality can be internalized by assigning property rights? How do you think this might work?

Answer 1

Consider the market of “Durian”. So, in the given fig “D1” be the demand for “Durian” and “S1” be the supply of “Durian”, => given the demand and supply curve “E1” be the equilibrium where and “Q1” and “P1” be the equilibrium quantity demanded and quantity supplied of “Durian”. Here we can see that “S1” be the “marginal private cost” curve and “S2” be the “marginal social cost curve”, => “Q1” is not the socially efficient output.

So, here there is a “external cost” of the production of “Durian” and the external cost is given by the vertical difference between “S2” and “S1”. So, here if the supplier reduces the supply of “Durian”, such that the new supply curve is “S2” then the socially optimum level of “Q” will be the produced and will be sold. So, if the property right is assigned against the seller of “Durian” and a tax is imposed per unit of “Durian” sold by the amount of the “external cost”, then the “supply curve” will shift upward to “S2” and the socially optimum level of output will be sold and the socially efficient price.

So, this one way to internalize the externality by assigning the property rights against the sellers of “Durian”.