Coase_Example - 1 The Reciprocal Nature of Externalities...

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1 The Reciprocal Nature of Externalities : The Coase Theorem Ronald Coase , an economist who won the Nobel Prize in 1991, identified an important aspect of externalities in a famous article, "The Problem of Social Cost." Coase noted that it takes two parties to create an externality--the producer or consumer, and the other party affected. If there were no people in the neighborhood of the pollution, there would be no negative externality. Coase's Railroad In Coase's paper, he provides a simple illustration of the reciprocal nature of externalities. Imagine that there is a railroad operating in the nineteenth century, using steam or wood burning technology, which creates sparks. The railroad runs through farmland, and the sparks can cause crop damage by burning the crops near the railroad tracks. The monetary damages to the farmer may be limited, either by limiting the number of trains running through the farmland, or by limiting the number of acres the farmer plants. Table 19A.1 shows the payoffs (gross profits) to both the farmer and the railroad for various combinations of trains and acres planted:
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2 a. Gross Profits RR has the property right Railroad Trains per Day Farmer (Acres Planted) Railroad Trains per Day b. Gross Profits RR has the liability Farmer (Acres Planted) 0 1 2 0 10 20 0 1 2 0 10 20 0 0 0 $1,000 $1,000 $1,000 $1,500 $1,500 $1,500 0 0 0 $1,000 $400 -$200 $1,500 $300 -$900 0 $1,500 $1,600 0 0 $900 $400 $300 -$800 0 0 0 $1,500 $1,600 $1,500 $1,500 $1,600 $1,600 Table 19A.1. Coasian Bargaining (Excluding Side Payments and Transaction Costs)
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