Coase Theorem

COASE THEOREM

If the value to the owner of the property right is less than the value to the other party of acquiring that right, a contract can be struck.

There has to be a "spread" in the value of the property right to each party, and transactions costs cannot be greater than that spread.

One has to be able to identify the source of the damage in order for the private market to have these kinds of agreements. In cases where the source is diffuse and difficult to identify, the role of government may be more likely.

POLLUTION PERMITS

The cost to the steel mill of reducing pollution by that last 100 tons of glop is greater than $5 million, whereas for the paper mill the cost of reduction of another 100 tons is less than $5 million. So it pays both of them to engage in this trade. The steel mill gets out of a larger than $5 million cost by paying $5 million and not having to reduce by that last 100 tons. Whereas the paper mill takes the $5 million and completes its side of the bargain, reduction by 100 tons, for a cost less than $5 million. Both are ahead.

We accomplish the same total reduction in glop. We just do so by changing the allocation of who does it to a more efficient pattern.

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This page was last updated on Friday, July 21, 2006.