BUSAD 120 Chapter Notes - Chapter 8: Coase Theorem, Externality, Economic Equilibrium
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Coase theorem: if private parties can bargain without cost over the allocation of resources, they can reach agreements or bargains that solve the problem of externalities on their own (without government intervention) The theorem applies whatever the initial distribution of legal rights (over resources) among the parties. Fred likes to party late at night and this disturbs his neighbour barney. Fred has a legal right to party. Fred estimates the benefit of partying to be . Barney estimates the cost of being disturbed (i. e. the negative externality) to be . Fred and barney are the only two parties involved. First, note that a social planner that would like to reach the socially efficient solution would eliminate late night partying. Because the value to society of the late night party = < cost to society = . The same outcome can be reached if fred and barney bargain: For instance, barney can offer fred to stop partying.
