Coase Theorem and Property Rights

Overview

This lecture covers the Coase Theorem, focusing on the role of property rights in achieving efficient outcomes, using a pollution example. It also discusses the trade-off between economic output and environmental protection.

Coase Theorem Basics

• The Coase Theorem states that with clearly defined property rights and zero transaction costs, the efficient outcome will be achieved regardless of who holds the rights.
• "Efficient outcome" means the allocation that maximizes total combined profit (or minimizes total cost).
• Negotiation between parties ensures that resources are allocated efficiently when property rights are clear.

Pollution Example: Lab and Lodge

• Two parties: a research lab that pollutes a lake and a lodge that loses profits due to pollution.
• If the lab does not recycle, lab profit = $16,000/week, lodge profit = $10,000/week; total = $26,000.
• If the lab recycles (at cost $6,000), lab profit = $10,000/week, lodge profit = $18,000/week; total = $28,000.
• Efficient outcome: lab recycles because total profit is higher.

Impact of Property Rights Assignment

• If the lab has property rights to pollute, the lodge can pay the lab to recycle; both benefit from a negotiated deal.
• If the lodge has property rights, the lab must recycle or compensate the lodge; recycling becomes the outcome.
• When recycling costs rise to $9,000 and lodge losses are $8,000, efficient outcome shifts to allowing pollution, regardless of property rights.

Trade-offs: Economic Output vs. Environmental Protection

• Reducing pollution often means less economic output; increasing output can harm the environment.
• Policy debates focus on balancing environmental protection with economic gains, but often downplay associated costs.

Key Terms & Definitions

• Coase Theorem — The principle that efficient outcomes occur if property rights are defined and transaction costs are zero, regardless of who holds the rights.
• Transaction cost — The costs of negotiating and enforcing agreements.
• Efficient outcome — The allocation that maximizes total benefit or minimizes total cost.
• Property rights — Legal rights to use or control a resource.

Action Items / Next Steps

• Review and understand the Coase Theorem for homework questions.
• Prepare to apply these concepts to problems involving costs, not profits.
• Reflect on real-world trade-offs between environmental policies and economic output.