Externalities and the Coase Theorem

mnmeconomics

The Coase theorem is a method of tackling the inefficiency caused by an externality, by awarding property rights to the externality to one party and allowing the parties concerned to bargain their way to an efficient solution. In the case of a negative externality such as pollution, the property right to pollute could be awarded to the polluter, and the victim of the pollution would have to offer to pay to get the polluter to reduce their output. Alternatively, the property right to clean air/water/whatever else is being polluted, could be awarded to the victim, so the polluter would have to offer to pay the victim to be allowed to pollute.

Consider the situation where we have a firm, firm A, producing some good in a competitive market that causes some pollution as a result of its output. Another firm, firm B, which produces a different good in a different…

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