welcome back this is our last video from chapter 12 we're going to talk about the coast theorem which is how better define property right so the idea is that one way to make create an efficient outcome is to make sure the property rights are understood okay i don't i know you have no idea what that means but let's get into it so the coast theorem that's what this whole thing is about i want you to remember this there is a home request your homeland question is basically on the coast theorem so write this down this is the thing you need to know okay for your homework you need to know this with defined property rights and no transaction cost the efficient outcome will be achieved so what that means is regardless of who gets the property rights i'll explain what that means when we go through our example regardless of who gets the property rights as long as we know who gets whose property rights they are you end up with the efficient outcome through negotiation okay let me show you with an example so kavila consider a village with a lake the village has a hiking lodge where visitors use the lake for recreation the village also has a research lab that creates industrial waste which dumps into lake this pollutes the lake and makes a less desirable vacation destination therefore reducing the lodge's profits okay so you see the problem there is pollution going on here and the pollution directly harms this lodge okay so suppose it's possible the lab could use an alternative production method that involves water recycling that will reduce the pollution in the lake to safe levels so lodge would no longer have to lose profit sounds good but what if it's expensive so without the recycling technology we're gonna say that the lab makes sixteen thousand dollars per week using the recycling technology will cost them six thousand dollars a week so they'll reduce it reduce their profit to ten thousand per week so that's the framing of our pro of our problem is that if the flab is going to use this technology it's gonna cost them six thousand dollars meanwhile while the lab is polluting the lodge remember that our story was the lodge loses profit because the lake is less usable so with the pollution from the lab the lodge would make ten thousand dollars per week if the lab recycled the largest profit would go up to eighteen thousand dollars per week we're gonna assume there's no transaction cost meaning you know if there's a payment between one from the other it's just it's instantaneous so first question which is the efficient outcome remember efficiency is about putting on the hat of saying i'm not taking the lab side i'm not taking the largest side i want the overall pie to be the largest okay so in this case since we're given our information in terms of profits we just want to know where the combined profit is the highest because that means the pi is the largest okay hopefully you're watching this video before you do your homework in the homework it's about cost not about profit so the most efficient outcomes be the one the lowest cost okay so what is the efficient outcome consider the total combined profit if the lab does not recycle then if the lab does not recycle then the lab makes sixteen thousand and the lodge makes ten thousand total of twenty six thousand if the lab does recycle the lab makes ten thousand large makes eighteen thousand a total of twenty eight thousand so the efficient outcome is for the lab to recycle suppose the lab has the property rights meaning they conclude and the lodge has no legal claim what would the lodge do okay so this is where the coast theorem comes into play once you define the property rights so here we're going to say the lab has the right to pollute that water legally they can if they can pollute and the lodge tries to sue them the judge will say but the lab's allowed to pollute there they have the rights to this water right this is something that needs to be defined remember that's the whole story here is defining property rights is crucial to getting an efficient outcome so what happens if the lab has the property rights okay so well the lodge loses eight thousand dollars per week when the lab pollutes right the lab saves six thousand per week by polluting so there's some range of outcomes where they could negotiate to get the lodge to lab to recycle take an example of seven thousand dollars if the lodge offered seven thousand dollars let's go look back at these numbers let's save a lot the lodge offers seven thousand dollars i will pay you lab i'll pay you seven thousand dollars if you recycle does the lab take this deal well they're making sixteen thousand per week if they recycle they make ten thousand plus the seven thousand they're getting paid that's seventeen thousand that's more than when they're polluting they take the deal does the lodge interested in this deal well when the lab is producing they make ten thousand dollars if they could get the lab to start recycling they would make eighteen thousand dollars well it would cost them seven thousand dollars to get this done eighteen thousand minus seventeen thousand is eleven thousand that's more than ten thousand so yes they will do it and that's the idea here is that that efficient outcome so once you've decided what the efficient outcome is the coase theorem says that outcomes gonna happen that's your takeaway here please commit that to memory once you've determined which is the efficient outcome the coase theorem says that outcome is going to happen so the efficient outcome is the lab recycles through this negotiation the lab recycles suppose the lodge has the property rights meaning they can legally prevent the lab from polluting what will the lab do will they use the technology or they pay the lodge for permission to pollute okay there's no deal that can be done here remember it cost them six thousand dollars to use the recycling technology the law just saving eight thousand without the polluting they're going to force the lab to pollute to recycle there's no deal that could be made here so that the lab ends up with uh being able to pollute so if the lab has the property rights the lodge pays them recycle if the lodge has the property rights the lab has to recycle because the alternative is they have to pay damages either they're gonna have to pay eight thousand dollars in damage to lodge or they're gonna pay six thousand dollars recycle they're gonna pay the six thousand recycle so that is our story here okay the coast theorem says is once you've created decide what the efficient outcome is then no matter who gets the property rights that efficient outcome is going to occur so imagine instead the cost use recycling technology was 9 000 instead how does that change your previous answers well if it costs 9 000 to recycle instead that means this goes down so this is 9 000 and this becomes 7 000. well now the efficient outcome is polluting right because at sixteen thousand dollars per week plus ten is twenty six seven thousand plus 18 is 25 is more efficient to allow the lab to pollute so if the lab has the property rights they're going to pollute can the lodge pay them in order to stop them from polluting well the only thing the lodge is willing to pay is up to eight thousand dollars that's what they're losing and if it costs them nine thousand dollars to recycle the lab is gonna say sorry thank you for that offer of eight thousand dollars or whatever but it's not worth it we're going to pollute instead if the lodge has the property rights well now there's probably a deal that's going to be made right because the law the the lodge has sorry because the lodge now has the primaries they can stop the lab from polluting or the lab is going to have to pay them their damages so by polluting the lab lodges losing eight thousand dollars so they can charge the lab eight thousand dollars to make them whole again and the lab will do that right because paying the lodge eight thousand dollars is cheaper than nine thousand dollars to recycle so once we've established that with these new numbers the efficient outcome is now the lodge the lab pollutes then when no matter who abs the property writes the lab pollutes okay so in example number one it was efficient for the lab to recycle so the lab had the property rights the lab recycled if the lodge had the property rights the lab recycled in example number two the efficient outcome was polluting if the lab had the property rights the lab polluted if the lodge had the property rights the lab polluted so you the more the story is though who has the property rights can determine a lot between who's going to end up with more profits who's getting up happier no matter what the efficient outcome happens that's the moral of the cost theorem so the last thing i'm going to do in this chapter and it's just one slide from the end of the book but i thought it was important is this idea of some sort of trade-off between economic output and environmental production protection this seems pretty inherent in the sort of in the fundamental reality of our economy is that when you are witnessing negative externalities that sort of hurt the environment or hurt society outside the transactions then our theory here is that that means that the free market's overproducing that means there's too much of pollution going on too much production going on so in order to rein that in through any of these regulations we've seen in this chapter that would could create the mo the more efficient outcome it could create the more efficient outcome but often that outcome means less economic output so in our refrigerator example that we've seen throughout this chapter the efficient outcome meant less refrigerators being produced produced so that's what we mean by a trade-off between environmental production and economic output and that's realistically true and so when we think about the debates over environmental production in this country that's what we hear about that's what we're talking about we're talking about where is your preference along this ppf remember ppf's from way back in chapter two and what we said is we're not sure which one of these spots is the best ever and that's the reality of our society in the world society when you think about pulling us out of the paris crime accord when you think about the the the dismantling of the epa this is because the trump administration wanted more economic output at the cost of environmental production so they're probably moving us from like r to q the buying administration comes in and now wants to put us back in the parent the paris climate accord wants to re-bolster the epa because they believe environmental protection is more valuable than economic output um but just to be clear and this is kind of one of the like the most important things i think um when you look at a graph like this is understanding that realistically we're talking about trade-offs that we realize that both sides realize means you're getting something and losing something else i believe that people who argue for less regulation to increase economic output would prefer a more protected environment but not at the cost of economic output and i certainly know that people on the left or people who are arguing in favor of environmental protection are would love higher economic output but not the cost of environmental protection so that's where this trade-off circum are concerned when you hear political discourse about this or about anything what you hear from both sides is the benefits of what they're proposing and ignoring the cost okay you will always hear people who are arguing in favor of environmental protection crowing about the the environmental protection and just sort of ignoring the fact that economic output is likely lost as a result likewise when you hear people from the other side of the aisle talking about deregulation or or or taking away environmental policies they're crowing about how it's going to impact economic output how good this is going to be for the economy for jobs et cetera and they're not going to tell you how much it's going to hurt the environment and that's what's frustrating i think any good policy debate says this is the cost and this is the benefit let's decide which one is greater that's not the reality in political discourse in this country not least now maybe ever i don't want to say like there was a time when people used to do this they probably never did instead you have one side saying here's the benefits of my choice the other side is saying this is the benefits of my choice and at both sides ignoring the cost and so i just thought looking at this graph kind of gives you the impression of what i'm talking about okay i hope you enjoyed this chapter i will see you next time