eep101 section4

eep101 section4 - MathReview (Lecture7&8) 1...

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February 5, 2008 Math Review 1 Property Rights (Lecture 7) 1. Understanding Coase Theorem A dentist and a writer work in offices next to each other. Screams of pain from the patients in the dentist’s office do not let the writer produce her novel, causing her to write mediocre stories and lose $800 per year in income. The dentist would have to spend $600 to install sound absorbing material on her office walls that would have to be replaced each year. The writer sues the dentist. The court can rule in favor of the author and require the dentist to soundproof her walls, or it can rule in favor of the dentist and dismiss the case. Explain what would happen under each ruling if: a. The dentist and the writer are on speaking terms and there are very small transaction costs and no court fees. Court rules in favor of dentist Court rules in favor of writer The dentist would have no incentive to soundproof her walls. By the Coase theory we know that if property rights are clearly defined and transaction costs are low, then an efficient resolution of externalities will be reached. In this case the writer would have the incentive to pay the dentist $600 to soundproof her walls. The writer would be better off by paying than by not paying the $600 and losing $800 from the screams. The efficient outcome would be reached because the writer would internalize the negative externality. The dentist would have to pay $600 to soundproof her walls. The dentist would be forced to internalize the costs of the negative externality. Since these costs are internalized, the efficient outcome will be reached. B. They are not speaking to each other under any circumstances and thus, have large transaction costs. 1 Problem 1 from unknown and Prof. Gaudin; Problem 2 from unknown
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Court rules in favor of the dentist Court rules in favor of the writer Since they are not in speaking terms, the cost of negotiation would be high. Thus, in addition to paying the dentist the $600, the writer would also incur the costs of negotiating an agreement. IF these costs exceeded $200 per year, then the writer would not have the
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eep101 section4 - MathReview (Lecture7&8) 1...

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