08. Coase's 'Theorem'

# 08. Coase's 'Theorem' - ECON 201 Shomu Banerjee NOTES ON...

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ECON 201 Shomu Banerjee NOTES ON COASE’S “THEOREM” Ronald Coase won the 1991 Economics Nobel Prize "for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy". He’s probably best known for the so-called Coase “theorem” which he never formally stated but is generally interpreted as follows: The equilibrium level of an externality (e.g., pollution) is independent of the assignment of property rights (including the assignment of liability for damage) so long as there are no transactions cost or income effects. What Coase appears to be saying is that if a firm pollutes and causes harm on others, the equilibrium level of externality will be the same whether the firm has the right to pollute or whether the harmed people have the right to clean air or anything in between. In the following analysis, we study under what circumstances the level of externality will be independent of the assignment of property rights. Suppose A and B are roommates and there is a good x which both person A and B care about, and another good y (e.g., smoking) which A cares about but B does not. Suppose their utility functions are quasilinear given by u A ( x a , y ) = x a + f ( y ) and u B ( x b , y ) = x b - g ( y ). Note that y (the right to smoke) enters as a public ‘good’ for A and a ‘bad’ for B : there is no ‘ a ’ or ‘ b ’ superscript for this good because both consume the same level of this good. The indifference curves for

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08. Coase's 'Theorem' - ECON 201 Shomu Banerjee NOTES ON...

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