Question

Suppose wheat producers convince the government that the real issue stems from the fact that the air space around farms do not have well defined property rights. It the government assigns the property rights tor the surrounding air to producers, then leave citizens and wheat producers to negotiate freely, will this produce a socially optimal outcome?

(This is in the context of negative market externalities)

Answer 1

Negative extenalities are the additional costs that are imposed on third party. They usually arise when the economy produces more than the socially optimum quantity. The above solution suggested is also known as the Coase theorem which stated that when it is possible to trade in an extenality with low transaction costs, the market will solve itself. Coase theorem suggests allocation of property for the market to acheive equilibrium.

When the wheat producers get the property rights to the air space around farms, they can now trade this air space with others. If the citizens want to have less pollution around the area, they can purchase the air space around the farm from the farmers and hence, have the established rights to that air space. The amount that the citizens are willing to pay must be equal to what the farmers are willing to accept for the economy to reach equilibrium.