微观经济学（第八版-英文）课件：Externalities and Public Goods

18.1

Externalities18.2

WaysofCorrectingMarketFailure18.3

StockExternalities18.4

ExternalitiesandPropertyRights18.5

CommonPropertyResources18.6

PublicGoods18.7 PrivatePreferencesforPublicGoods

ExternalitiesandPublicGoodsCHAPTEROUTLINEInthischapterwestudyexternalities—theeffectsofproductionandconsumptionactivitiesnotdirectlyreflectedinthemarket—andpublicgoods—goodsthatbenefitallconsumersbutthatthemarketeitherundersuppliesordoesnotsupplyatall.Whenexternalitiesarepresent,thepriceofagoodneednotreflectitssocialvalue.Asaresult,firmsmayproducetoomuchortoolittle,sothatthemarketoutcomeisinefficient.Themarginalcostofprovidingapublicgoodtoanadditionalconsumeriszero,andpeoplecannotbepreventedfromconsumingit.Wedistinguishbetweenthosegoodsthataredifficulttoprovideprivatelyandthosethatcouldhavebeenprovidedbythemarket.Externalities18.1●

externality Actionbyeitheraproduceroraconsumerwhich

affectsotherproducersorconsumers,butisnotaccountedforinthemarketprice.NegativeExternalitiesandInefficiencyExternalitiescanbenegative—whentheactionofonepartyimposescostsonanotherparty—orpositive—whentheactionofonepartybenefitsanotherparty.●

marginalexternalcost Increaseincostimposedexternallyasoneormorefirmsincreaseoutputbyoneunit.●

marginalsocialcost Sumofthemarginalcostofproductionandthemarginalexternalcost.EXTERNALCOSTFIGURE18.1(1of2)Whentherearenegativeexternalities,themarginalsocialcostMSCishigherthanthemarginalcostMC.ThedifferenceisthemarginalexternalcostMEC.In(a),aprofit-maximizingfirmproducesatq1,wherepriceisequaltoMC.Theefficientoutputisq*,atwhichpriceequalsMSC.EXTERNALCOSTFIGURE18.1(2of2)In(b),theindustry’scompetitiveoutputisQ1,attheintersectionofindustrysupplyMCanddemandD.However,theefficientoutputQ*islower,attheintersectionofdemandandmarginalsocialcostMSC.TheaggregatesocialcostisastheshadedtrianglebetweenMSCI,D,andoutputQ1.PositiveExternalitiesandInefficiency●

marginalexternalbenefit Increasedbenefitthataccruestoother

partiesasafirmincreasesoutputbyoneunit.●

marginalsocialbenefit Sumofthemarginalprivatebenefitplusthemarginalexternalbenefit.Whentherearepositiveexternalities,marginalsocialbenefitsMSBarehigherthanmarginalbenefitsD.ThedifferenceisthemarginalexternalbenefitMEB.Aself-interestedhomeownerinvestsq1

inrepairs,determinedbytheintersectionofthemarginalbenefitcurveDandthemarginalcostcurveMC.Theefficientlevelofrepairq*ishigherandisgivenbytheintersectionofthemarginalsocialbenefitandmarginalcostcurves.EXTERNALBENEFITSFIGURE18.2Althoughsulfurdioxidegascanbeproducednaturallybyvolcanoes,almosttwo-thirdsofallsulfurdioxideemissionsintheUnitedStatescomefromelectricpowergenerationthatdependsonburningfossilfuelssuchascoalandpetroleum.Inadditiontohumanhealth,acidraincausesdamagetowaterandforestsaswellastoman-madestructures.SULFURDIOXIDEEMISSIONSREDUCTIONSFIGURE18.3EXAMPLE18.1THECOSTSANDBENEFITSOFSULFURDIOXIDEEMISSIONSTheefficientsulfurdioxideconcentrationequatesthemarginalabatementcosttothemarginalexternalcost.Herethemarginalabatementcostcurveisaseriesofsteps,eachrepresentingtheuseofadifferentabatementtechnology.WaysofCorrectingMarketFailure18.2WecanencouragethefirmtoreduceemissionstoE*inthreeways:(1)emissionsstandards;(2)emissionsfees;and(3)transferableemissionspermits.THEEFFICIENTLEVELOFEMISSIONSFIGURE18.4TheefficientleveloffactoryemissionsisthelevelthatequatesthemarginalexternalcostofemissionsMECtothebenefitassociatedwithlowerabatementcostsMCA.Theefficientlevelof12unitsisE*.AnEmissionsStandard●emissionsstandard Legallimitontheamountofpollutantsthat

afirmcanemit.●emissionsfeeChargeleviedoneachunitofafirm’semissions.AnEmissionsFeeThestandardensuresthatthefirmproducesefficiently.Thefirmmeetsthestandardbyinstallingpollution-abatementequipment.Firmswillfinditprofitabletoentertheindustryonlyifthepriceoftheproductisgreaterthantheaveragecostofproductionplusabatement—theefficientconditionfortheindustry.STANDARDSANDFEESFIGURE18.5TheefficientlevelofemissionsatE*canbeachievedthrougheitheranemissionsfeeoranemissionsstandard.Facingafeeof$3perunitofemissions,afirmreducesemissionstothepointatwhichthefeeisequaltothemarginalcostofabatement.Thesamelevelofemissionsreductioncanbeachievedwithastandardthatlimitsemissionsto12units.StandardsversusFeesTHECASEFORFEESTHECASEFORFEESFIGURE18.6Withlimitedinformation,apolicymakermaybefacedwiththechoiceofeitherasingleemissionsfeeorasingleemissionsstandardforallfirms.Thefeeof$3achievesatotalemissionslevelof14unitsmorecheaplythana7-unit-per-firmemissionsstandard.Withthefee,thefirmwithalowerabatementcostcurve(Firm2)reducesemissionsmorethanthefirmwithahighercostcurve(Firm1).THECASEFORSTANDARDSTHECASEFORSTANDARDSFIGURE18.7Whenthegovernmenthaslimitedinformationaboutthecostsandbenefitsofpollutionabatement,eitherastandardorafeemaybepreferable.Thestandardispreferablewhenthemarginalexternalcostcurveissteepandthemarginalabatementcostcurveisrelativelyflat.Herea12.5percenterrorinsettingthestandardleadstoextrasocialcostsoftriangleADE.ThesamepercentageerrorinsettingafeewouldresultinexcesscostsofABC.TradableEmissionsPermits●

tradableemissionspermits

Systemofmarketablepermits,

allocatedamongfirms,specifyingthemaximumlevelofemissionsthatcanbegenerated.Underthissystem,eachfirmmusthavepermitstogenerateemissions.Eachpermitspecifiesthenumberofunitsofemissionsthatthefirmisallowedtoputout.Anyfirmthatgeneratesemissionsnotallowedbypermitissubjecttosubstantialmonetarysanctions.Permitsareallocatedamongfirms,withthetotalnumberofpermitschosentoachievethedesiredmaximumlevelofemissions.Permitsaremarketable:Theycanbeboughtandsold.Ifthereareenoughfirmsandpermits,acompetitivemarketforpermitswilldevelop.Inmarketequilibrium,thepriceofapermitequalsthemarginalcostofabatementforallfirms;otherwise,afirmwillfinditadvantageoustobuymorepermits.Thelevelofemissionschosenbythegovernmentwillbeachievedatminimumcost.Thosefirmswithrelativelylowmarginalcostofabatementcurveswillbereducingemissionsthemost,andthosewithrelativelyhighmarginalcostofabatementcurveswillbebuyingmorepermitsandreducingemissionstheleast.Takentogether,sulfurdioxideemissionsproducedthrough

theburningofcoalforuseinelectricpowergenerationand

thewideuseofcoal-basedhomefurnaceshavecauseda

hugeprobleminBeijingaswellasothercitiesinChina.

Notonlyhaveemissionscreatedanacidrainproblem,but

theyhavecombinedwithemissionsfromthegrowingnumber

ofautomobilestomakeBeijingoneofthemostpollutedcities

notonlyinChina,butintheworld.In1995,forexample,thelevelofsulfurdioxideinBeijingwas

90milligramspercubicmeter,whichcomparesunfavorablyto

Berlin(18mg/m3),Copenhagen(7),London(25),NewYork(26),Tokyo(18),andMexicoCity(74).Ofthemajorcitiesintheworld,onlyMoscowhadhighersulfurdioxidelevels(109mg/m3).ToreducesulfurdioxideemissionssoastoofferacleanerenvironmenttotheOlympicathletesandtothevisitingpublic,Beijing’schoicewastoshutdownalargenumberofcoal-firedplants.TheairqualityinBeijingimproved30percentin2008fortheOlympics,atacostofabout$10billion.ButayearaftertheGames,whenmanyoftheenvironmentalregulationswerenolongerineffect,about60percentoftheimprovementwaslost.EXAMPLE18.2REDUCINGSULFURDIOXIDEEMISSIONSINBEIJINGAstudyoftheregulationofelectric-utilitysulfurdioxide

tradeableemissionsshowsthatmarketablepermitsinthe

UnitedStatescancutinhalfthecostofcomplyingwitha

regulatory-basedstandard.CansimilargainsbeachievedinBeijing?Theanswerliesin

partonwhetherthemarketfortradeableemissionswillitself

workefficiently.Butitalsodependsontheshapeofthe

marginalabatementcostandmarginalexternalcostcurves.Asourpriordiscussionhasshown,thecaseforemissions

fees(andfortradeablepermits)isstrongest(1)whenfirmsvarysubstantiallyintheirmarginalabatementcosts;and(2)whenthemarginalexternalcostofemissionscurveisrelativelysteepandthemarginalcostofabatementcurverelativelyflat.EXAMPLE18.2REDUCINGSULFURDIOXIDEEMISSIONSINBEIJINGTheEnvironmentalProtectionAgency’s“bubble”and“offset”programsweremodestattemptstouseatradingsystemtolowercleanupcosts.Abubbleallowsanindividualfirmtoadjustitspollutioncontrolsforindividualsourcesofpollutantsaslongasatotalpollutantlimitforthefirmisnotexceeded.Intheory,abubblecouldbeusedtosetpollutantlimitsformanyfirmsorforanentiregeographicregion;inpractice,however,ithasbeenappliedtoindividualfirms.Asaresult“permits”are,ineffect,tradedwithinthefirm:Ifonepartofthefirmcanreduceitsemissions,anotherpartwillbeallowedtoemitmore.AbatementcostsavingsassociatedwiththeEPA’sprogramof42bubbleshavebeenapproximately$300millionperyearsince1979.Undertheoffsetprogram,newsourcesofemissionsmaybelocatedinregionsinwhichair-qualitystandardshavenotbeenmet,butonlyiftheyoffsettheirnewemissionsbyreducingemissionsfromexistingsourcesbyatleastasmuch.Offsetscanbeobtainedbyinternaltrading,butexternaltradingamongfirmsisalsoallowed.Atotalofmorethan2000offsettransactionshaveoccurredsince1976.Becauseoftheirlimitednatures,bubbleandoffsetprogramssubstantiallyunderstatethepotentialgainfromabroad-basedemissionstradingprogram.Thepotentialcostsavingsfromaneffectivetradeableemissionsprogramcanbesubstantial.EXAMPLE18.3EMISSIONSTRADINGANDCLEANAIREXAMPLE18.3EMISSIONSTRADINGANDCLEANAIRStartingin2007,themarketpriceofemissionpermitsbegantodecline,inpartbecausetheEPAlostalawsuitbroughtbyagroupofutilities.Permitpricesfellprecipitouslyaftertheruling,andthemarketfinallybottomedoutin2010,whentheEPAissuednewrulesthatrequiremostemissionsreductionstocomefromchangesatindividualplantsandthatlimittheuseofpermitallowances.FIGURE18.8Thepriceoftradeablepermitsforsulfurdioxideemissionsfluctuatedbetween$100and$200intheperiod1993to2003,butthenincreasedsharplyduring2005and2006inresponsetoanincreaseddemandforpermits.Sincethen,thepricehasfluctuatedaround$400to$500perton.PRICEOFTRADEABLEEMISSIONSPERMITSRecyclingTotheextentthatthedisposalofwasteproductsinvolveslittleorno

privatecosttoeitherconsumersorproducers,societywilldisposeof

toomuchwastematerial.Theoverutilizationofvirginmaterialsandtheunderutilizationofrecycledmaterialswillresultinamarketfailurethatmayrequiregovernmentintervention.Fortunately,giventheappropriateincentivetorecycleproducts,thismarketfailurecanbecorrected.Inmanycommunities,householdsarechargedafixedannualfeefortrashdisposal.Asaresult,thesehouseholdscandisposeofglassandothergarbageatverylowcost.Thelowcostofdisposalcreatesadivergencebetweentheprivateandthesocialcostofdisposal.Themarginalprivatecost,whichisthecosttothehouseholdofthrowingouttheglass,islikelytobeconstant(independentoftheamountofdisposal)forlowtomoderatelevelsofdisposal.Itwillthenincreaseforlargedisposallevelsinvolvingadditionalshippinganddumpcharges.Incontrast,thesocialcostofdisposalincludestheharmtotheenvironmentfromlittering,aswellastheinjuriescausedbysharpglassobjects.Marginalsocialcostislikelytoincrease,inpartbecausethemarginalprivatecostisincreasingandinpartbecausetheenvironmentalandaestheticcostsoflitteringarelikelytoincreasesharplyasthelevelofdisposalincreases.THEEFFICIENTAMOUNTOFRECYCLINGFIGURE18.9Theefficientamountofrecyclingofscrapmaterialistheamountthatequatesthemarginalsocialcostofscrapdisposal,MSC,tothemarginalcostofrecycling,MCR.Theefficientamountofscrapfordisposalm*islessthantheamountthatwillariseinaprivatemarket,m1.Therefundabledepositcreatesanadditionalprivatecostofdisposal:theopportunitycostoffailingtoobtainarefund.Withthehighercostofdisposal,theindividualwillreducedisposalandincreaserecyclingtotheoptimalsociallevelm*.REFUNDABLEDEPOSITSFIGURE18.10ThesupplyofvirginglasscontainersisgivenbySvandthesupplyofrecycledglassbySr.ThemarketsupplyS

isthehorizontalsumofthesetwocurves.Initially,equilibriuminthemarketforglasscontainersinvolvesapricePandasupplyofrecycledglassM1.Byraisingtherelativecostofdisposalandencouragingrecycling,therefundabledepositincreasesthesupplyofrecycledglassfromSr

toS’r

andtheaggregatesupplyofglassfromStoS’.ThepriceofglassthenfallstoP’,thequantityofrecycledglassincreasestoM*,andtheamountofdisposedglassdecreases.REFUNDABLEDEPOSITSEXAMPLE18.4REGULATINGMUNICIPALSOLIDWASTESBy1990,theaverageresidentofLosAngeleswas

generatingabout6.4poundsofsolidwasteperday,

andresidentsofotherlargeAmericancitieswerenot

farbehind.Bycontrast,residentsofTokyo,Paris,

HongKong,andRomegenerated3pounds,2.4

pounds,1.9pounds,and1.5pounds,respectively.Someofthesedifferencesareduetovariationsin

consumptionlevels,butmostareduetotheeffortsthatmanyothercountrieshavemadetoencouragerecycling.AnumberofpolicyproposalshavebeenintroducedtoencouragerecyclingintheUnitedStates.Refundabledeposits,curbsidechargesandmandatoryseparationofrecyclablematerialssuchasglass.Randomspotcheckswithsubstantialpenaltiesforviolationsarerequiredtomakethesystemeffective.Mandatoryseparationisperhapstheleastdesirableofthethreealternatives,notonlybecauseitisdifficulttoimplement,butalsobecauseindividuals,ifthecostofseparationissufficientlyhigh,maybeencouragedtoshifttoalternativecontainerssuchasplastic,whichareenvironmentallydamagingandcannotreadilyberecycled.StockExternalities18.3●

stockexternality Accumulatedresultofactionbyaproducerorconsumerwhich,thoughnotaccountedforinthemarketprice,affectsotherproducersorconsumers.Sometimes,thedamagetosocietycomesnotdirectlyfromthe

emissionsflow,butratherfromtheaccumulatedstockofapollutant.Agoodexampleisglobalwarming.Itisthestockofaccumulatedgreenhousegases(GHGs)intheatmospherethatultimatelycausesharm.Furthermore,thedissipationrateforaccumulatedGHGsisverylow.Stockexternalities(likeflowexternalities)canalsobepositive.Anexampleisthestockof“knowledge”thataccumulatesasaresultofinvestmentsinR&D.Overtime,R&Dleadstonewideas,newproducts,moreefficientproductiontechniques,andotherinnovationsthatbenefitsocietyasawhole,andnotjustthosewhoundertaketheR&D.Bycomparingthepresentdiscountedvalue(PDV)oftheadditionalprofitslikelytoresultfromtheinvestmenttothecostoftheinvestment,i.e.,bycalculatingtheinvestment’snetpresentvalue(NPV),thefirmcandecidewhetherornottheinvestmentiseconomicallyjustified.Thesamenetpresentvalueconceptapplieswhenwewanttoanalyzehowthegovernmentshouldrespondtoastockexternality.StockBuildupandItsImpact

TABLE18.1BUILDUPINTHESTOCKOFPOLLUTANTYEAREStDAMAGE

($BILLION)CostofE=0($BILLION)NETBENEFIT($BILLION)20101001000.1001.5–1.40020111001980.1981.5–1.30220121002960.2961.5–1.20421101004.3374.3371.52.8371005,0005.0001.53.500NUMERICALEXAMPLETable18.1showstheannualcostofreducingemissionsfrom100unitstozero,theannualbenefitfromavertingdamage,andtheannualnetbenefit(theannualbenefitnetofthecostofeliminatingemissions).Todeterminewhetherapolicyofzeroemissionsmakessense,wemustcalculatetheNPV,orthepresentdiscountedvalueoftheannualnetbenefits.DenotingthediscountratebyR,theNPVis:

TABLE18.2NPVOF“ZEROEMISSIONS”POLICYDiscountRate,RDissipationRate,

.01.02.04.06.08.01108.8154.0712.20–0.03

–4.08

.0265.9331.204.49–3.25–5.69.0415.483.26–5.70–7.82–8.81Note:EntriesintableareNPVsin$billions.Entriesfor

=.02correspondtonetbenefitnumbersinTable18.1.Table18.2showstheNPVasafunctionofthediscountrate.Table18.2alsoshowshowtheNPVofa“zeroemissions”policydependsonthedissipationrate,

.If

islower,theaccumulatedstockofpollutantwillreachhigherlevelsandcausemoreeconomicdamage,sothefuturebenefitsofreducingemissionswillbegreater.Formulatingenvironmentalpolicyinthepresenceofstockexternalitiesintroducesanadditionalcomplicatingfactor:Whatdiscountrateshouldbeused?●

socialrateofdiscount

Opportunitycosttosocietyasawholeofreceivinganeconomicbenefitinthefutureratherthanthepresent.Inprinciple,thesocialrateofdiscountdependsonthreefactors:(1)theexpectedrateofrealeconomicgrowth;(2)theextentofriskaversionforsocietyasawhole;and(3)the“rateofpuretimepreference”forsocietyasawhole.Withrapideconomicgrowth,futuregenerationswillhavehigherincomesthancurrentgenerations,andiftheirmarginalutilityofincomeisdecreasing(i.e.,theyarerisk-averse),theirutilityfromanextradollarofincomewillbelowerthantheutilitytosomeonelivingtoday;that’swhyfuturebenefitsprovidelessutilityandshouldthusbediscounted.Inaddition,evenifweexpectednoeconomicgrowth,peoplemaysimplyprefertoreceiveabenefittodaythaninthefuture(therateofpuretimepreference).Forproblemsinvolvinglongtimehorizons,thepolicydebateoftenboilsdowntoadebateoverthecorrectdiscountrate.Emissionsofcarbondioxideandothergreenhouse

gaseshaveincreaseddramaticallyoverthepast

centuryaseconomicgrowthhasbeenaccompanied

bythegreateruseoffossilfuels,whichhasinturn

ledtoanincreaseinatmosphericconcentrationsof

GHGs.GHGemissionscouldbereducedfromtheircurrentlevels—governments,forexample,couldimposestifftaxesontheuseofgasolineandotherfossilfuels—butthissolutionwouldbecostly.Theproblemisthatthecostsoccurtoday,butthebenefitswouldberealizedonlyinsome50ormoreyears.Isthepresentdiscountedvalueofthelikelybenefitsofsuchpoliciessimplytoosmall?Althoughthereisconsiderableuncertaintyovertheeconomicimpactofhighertemperatures,theconsensusviewisthattheimpactcouldbesignificant,sothattherewouldbeafuturebenefitfromreducingemissionstoday.Thecostofreducingemissions(orpreventingthemfromgrowingabovecurrentlevels)canbeassessedaswell,althoughheretoothereisuncertaintyoverthenumbers.WhetherapolicytorestrictGHGemissionsmakeseconomicsenseclearlydependsontherateusedtodiscountfuturecostsandbenefits.EXAMPLE18.5GLOBALWARMINGEXAMPLE18.5GLOBALWARMINGTABLE18.3REDUCINGGHGEMISSIONS“BUSINESSASUSUAL”EMISSIONSREDUCEDBY1%PERYEARYEAREtSt

TtDAMAGEEtSt

TtDAMAGECOSTNETBENEFIT2010504300°0504300°00.65–0.652020554600.5°0.54454600.5°0.430.83–0.722030624901°1.38414851°1.111.07–0.792040735201.5°2.66375101.4°2.131.36–0.832050855502°4.54335302°3.631.75–0.842060905802.3°6.77305502°5.812.23–1.272070956102.7°9.91275502°7.442.86–0.3820801006403°14.28255502°9.523.661.1020901056703.3°20.31225502°12.184.693.4421001107003.7°28.59205502°15.606.007.0021101157304°39.93185502°19.977.6812.28Notes:Et

ismeasuredingigatonnes(billionsofmetrictons)ofCO2equivalent(CO2e),Stismeasuredinpartspermillion(ppm)ofatmosphericCO2e,thechangeintemperature

TtismeasuredindegreesCelsius,andcosts,damages,andnetbenefitsaremeasuredintrillionsof2007dollars.CostofreducingEmissionsisestimatedtobe1%ofGDPeachyear.WorldGDPisprojectedtogrowat2.5%inrealtermsfromalevelof$65trillionin2010.Damagefromwarmingisestimatedtobe1.3%ofGDPperyearforevery1°Coftemperatureincrease.ExternalitiesandPropertyRights18.4●

propertyrights

Legalrulesstatingwhatpeopleorfirmsmaydowiththeirproperty.Toseewhypropertyrightsareimportant,let’sreturntoourexampleofthefirmthatdumpseffluentintotheriver.Weassumedboththatithadapropertyrighttousetherivertodisposeofitswasteandthatthefishermendidnothaveapropertyrightto“effluent-free”water.Asaresult,thefirmhadnoincentivetoincludethecostofeffluentinitsproductioncalculations.Inotherwords,thefirmexternalized

thecostsgeneratedbytheeffluent.Butsupposethatthefishermenhadapropertyrighttocleanwater.Inthatcase,theycoulddemandthatthefirmpaythemfortherighttodumpeffluent.Thefirmwouldeitherceaseproductionorpaythecostsassociatedwiththeeffluent.Thesecostswouldbeinternalizedandanefficientallocationofresourcesachieved.PropertyRightsEconomicefficiencycanbeachievedwithoutgovernmentinterventionwhentheexternalityaffectsrelativelyfewpartiesandwhenpropertyrightsarewellspecified.BargainingandEconomicEfficiencyAsTable18.4shows,thefactorycaninstallafiltersystemtoreduceitseffluent,orthefishermencanpayfortheinstallationofawatertreatmentplant.Theefficientsolutionmaximizesthejointprofitofthefactoryandthefishermen.Maximizationoccurswhenthefactoryinstallsafilterandthefishermendonotbuildatreatmentplant.TABLE18.4PROFITSUNDERALTERNATIVEEMISSIONSCHOICES(DAILY)FACTORY’SPROFIT($)FISHERMEN’SPROFIT($)TOTALPROFIT($)Nofilter,notreatmentplant500100600Filter,notreatmentplant300500800Nofilter,treatmentplant500200700Filter,treatmentplant300300600InTable18.5,underthecolumn“RighttoDump,”weseethatwithoutcooperation,thefishermenearnaprofitof$200andthefactory$500.Withcooperation,theprofitofbothincreasesby$50.Nowsupposethefishermenaregiventhepropertyrighttocleanwater,whichrequiresthefactorytoinstallthefilter.Thefactoryearnsaprofitof$300andthefishermen$500.Becauseneitherpartycanbemadebetteroffbybargaining,havingthefactoryinstallthefilterisefficient.Thisanalysisappliestoallsituationsinwhichpropertyrightsarewellspecified.TABLE18.5BARGAININGWITHALTERNATIVEPROPERTYRIGHTSNOCOOPERATIONRIGHTTODUMP($)RIGHTTOCLEANWATER($)Profitoffactory500300Profitoffishermen200500COOPERATIONProfitoffactoryProfitoffishermen250500●

Coasetheorem

Principlethatwhenpartiescanbargainwithoutcostandtotheirmutualadvantage,theresultingoutcomewillbeefficientregardlessofhowpropertyrightsarespecified.CostlyBargaining—TheRoleofStrategicBehaviorBargainingcanbetime-consumingandcostly,especiallywhenpropertyrightsarenotclearlyspecified.Inthatcase,neitherpartyissurehowhardtobargainbeforetheotherpartywillagreetoasettlement.Inourexample,bothpartiesknewthatthebargainingprocesshadtosettleonapaymentbetween$200and$300.Ifthepartiesareunsureofthepropertyrights,however,thefishermenmightbewillingtopayonly$100,andthebargainingprocesswouldbreakdown.Bargainingcanbreakdownevenwhencommunicationandmonitoringarecostlessifbothpartiesbelievetheycanobtainlargergains.Forexample,onepartymightdemandalargeshareandrefusetobargain,assumingincorrectlythattheotherpartywilleventuallyconcede.Anotherproblemariseswhenmanypartiesareinvolved.Suppose,forexample,thattheemissionsfromafactoryareadverselyaffectinghundredsorthousandsofhouseholdswholivedownstream.Inthatcase,thecostsofbargainingwillmakeitverydifficultforthepartiestoreachasettlement.ALegalSolution—SuingforDamagesToseehowthepotentialforalawsuitcanleadtoanefficientoutcome,let’sreexamineourfishermen–factoryexample.Supposefirstthatthefishermenaregiventherighttocleanwater.Thefactory,inotherwords,isresponsibleforharmtothefishermenifitdoesnotinstallafilter.Theharmtothefishermeninthiscaseis$400:thedifferencebetweentheprofitthatthefishermenmakewhenthereisnoeffluent($500)andtheirprofitwhenthereiseffluent($100).Thefactoryhasthefollowingoptions:1.Donotinstallfilter,paydamages:Profit=$100($500-$400)2.Installfilter,avoiddamages:Profit=$300($500-$200)Thefactorywillfinditadvantageoustoinstallafilter,whichissubstantiallycheaperthanpayingdamages,and