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COASE THEOREM:

COASE THEOREM:. 'the proposition that if parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own' (Mankiw, p. 210)

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COASE THEOREM:

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  1. COASE THEOREM: 'the proposition that if parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own' (Mankiw, p. 210) 'When transaction costs are zero the allocation of resources is independent of the distribution of property rights'

  2. COASE THEOREM • implication that when bargaining is costless resources will end up in their highest valued use • Outcome not one of zero pollution • Bargaining Costs

  3. At J: MBmill = Price – MC = 0 MCangl = KH > MBmill At L: Price - MCMill = ES MCAngl = ES £ At J’: Price – MCmill = H’R’ MCangl = K’R’ > H’R’ At M: Price - MC = NS’ MCAngl = TS < NS’ A N G’ K K’ E G T H’ H F’ R’ S S’ F L J’ M J B Q

  4. Economic Principle No. 7:"Governments can sometimes improve market outcomes" • Transaction costs "Costs that parties incur in the process of agreeing and following through a bargain" (Mankiw, p. 211) • Sources of transaction costs free riding strategic behaviour • Government mimics ideal market solution i.e. public solutions

  5. PUBLIC SOLUTIONS TO EXTERNALITIES • Regulation set of rules governing behaviour command and control e.g. emission standard • Pigovian Taxes increase polluters mc to mc to society bring market equilibrium to social optimum • Emission Charges effectively same as Pigovian tax

  6. POLLUTION PERMITS • grant right to generate specified level of pollution i.e. optimum level multiple polluters tradable permits • Market for Pollution Rights Mankiw Figure 10.5: demand curve for pollution rights MB of pollution rights = marg. profit of pollution Mprofit = MRevenue - MC see Supplement 1 and EPA web-link

  7. PUBLIC SOLUTIONS get 'best' outcome when they make agents internalise the externality i.e. complete the market

  8. More Missing Markets • Externalities arise from missing markets • Internalise by completing market (i) private solutions where TCs are low (ii) public solutions where TCs are high • Conditions for markets to work well

  9. Collective Property Rights • Over utilisation • Common grazing, fish stocks • Lack of husbanding/investment

  10. Common Resources • Non-excludable - don’t reveal value • Rivalness - conumption has opportunity cost • Over-utilisation

  11. Public Goods • Non-excludable - don’t reveal value • Non-rival - use has zero opportunity cost • Under-production by market • Typically provided by government e.g. defence, law and order, information • Not all goods supplied by govt. are pure public goods - Merit goods

  12. Merit goods • Market Consumption too low • Large external benefit e. g. health, education

  13. Role for Government • Externalities Low TCs - encourage private solutions - specify property rights High TCs - public solution - Pigovian taxes, standards, permits • Merit Goods Public subsidy - MSB> MB - public provision • Public Goods Non-excludability - free rider Non-rival (zero opp. Cost) - p = MC = 0 Market under-provides

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