- Coase theorem
- The Coase theorem says that if property rights are clear and bargaining is cheap, the parties to an externality bargain to the efficient outcome, whoever holds the right.
- Pigouvian tax
- A Pigouvian tax is a tax on an activity that causes an external cost, equal to the marginal external cost at the efficient output.
What can stop the bargain from happening
Can you name the four things that can stop a Coasean bargain from happening?
The theorem needs cheap, straightforward bargaining. Each of these makes bargaining costly or lopsided.
Transaction costs are the costs of making a deal happen: finding the other parties, working out the harm, negotiating, and writing and enforcing the agreement.
Can you think of an example?
A factory's smoke reaches one laundry, which can settle over a cup of tea. When the same smoke reaches a whole town, organising and paying lawyers for everyone can cost more than the harm.
The free-rider problem is that when many people gain from a deal, each hopes the others will pay for it, so too little is offered.
Can you think of an example?
Three thousand residents would all gain if a quarry cut its dust, but each hopes the rest will chip in to pay it, so the fund never reaches the price.
The hold-out problem is that when a deal needs everyone's agreement, each party can refuse until it is paid more than its true loss.
Can you think of an example?
A wind farm needs consent from all twelve neighbouring farms. The last farmer to sign can demand far more than the view is worth to him, and the deal can collapse.
A wealth effect here is that who holds the right changes how rich each side is, which can change what each values the right at.
Can you think of an example?
A struggling café next to a bakery's extractor fan might demand £120 a week to put up with the fumes if it holds the right, but could scrape together only £60 a week to pay for clean air if it does not.