How can Coase theorem be used to resolve negative externalities and improve efficiency? Explain clearly.

Expert Solution

According to “Coase Theorem” if property rights are specified properly with no transactions costs then socially optimum and efficient level of output can be produced by mutual agreement between two parties.

Consider an example there are two individuals one is “fisher man” and the other one is a “Firm owner” and the property right is assigned to the “fisher man”. So as the “firm owner” will produce goods and will emit pollutants into the river, it is adversely effects the “fisher man” as the harmful pollutants decrease the availability of fishes into the river. So, here “firm owner” is creating negative externality to the “fisher man”.

So, here the efficient as well as the socially optimum output production is below the current level of production. So, since here the property right is assigned to the “fisher man”, => the fisher man can charge a fixed fee equal to the “marginal damage” per unit of pollutant released. So, if the “fisher man” does these, => the producer will reduce the production as well as the level pollutant emission into the river and the socially optimum level of output will be produced.

Rahul Sunny answered 1 year ago

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