In: Economics
Write a short essay on externalities and the so-called Coase theorem. As part of your answer make sure that you discuss the circumstances under which private markets are most likely to come up with effective private solutions to the problem of externalities. In that context make sure to include at least one specific instance of a situation in which an effective market solution is feasible and also at least one example of a situation in which a private market solution would be all but inconceivable.
Externalities crop up if the activities of certain economic agents make some other economic agents better off / worse off, yet those economic agents neither shoulder the expenses nor obtain the gains of doing so .
Coase proposition (Part one)- When there are definite property entitlements & zero bargaining costs, then negotiations between the one giving rise to the externality & the one impacted it can lead to the socially optimum market quantity.
Coase proposition (Part two): The efficient outcome to an externality doesn’t rely on which party is ascribed the property rights, so long as someone is ascribed those rights.
Coase theorem-application:
Companies pollute a lake that some individuals enjoy. If companies ignore these individuals, there is excessive pollution
Situation 1) Individuals are owners: If the lake is owned by individuals then they can levy a charge on the companies for polluting the lake. They will charge the companies the marginal damage/ unit of pollution. Pollution is priced at MD as this is the equilibrium effective price level in the newly developed pollution market.
Situation 2) Firms are owners: If the lake is owned by the companies then the companies can levy a charge on individuals for polluting lesser. In this case charge will be MD / unit of pollution.
Ultimate level of pollution will be identical in 1) & 2)
Ascribing property rights is tough in situations where externalities impact big number of economic agents (example-global warming) ⇒ Coasian outcomes are likely to be more effectual for smaller & localized externalities than for large & more global ones concerning big number of persons & companies.