The Problem of Social Cost Pt. 2

Coase's Concerns

• Show the weaknesses of the traditional Pigou-type analysis.
• Explain that externalities are always reciprocal.
• Show how important transaction costs are for any proper economic analysis.
• Advocate for a fundamental change of approach in economics.

External Effects

• External effects occur when actions of an individual or organization impact others without full compensation.
• Negative external effects: Actions impose costs or disutility on others without compensation.
• Positive external effects: Actions provide utility or benefits to others without compensation.
• Consequences of actions are not fully considered in decision-making.
• Property rights may be poorly defined, or enforcement costs may be too high which may explain the reasoning behind this.

External Effect Examples

• Environmental pollution (noise, dirt, contamination).
• Smoking.
• Vaccination (analogous to anti-virus software).
• Monopoly pricing.
• Product innovations.
• Monument conservation.
• Network externalities.

Private, External, and Social Costs and Benefits

• Private surplus = Private returns - Private costs.
• External surplus = External returns - External costs.
• Social surplus = Social returns - Social costs.

Distinctions of Externalities

• Positive vs. negative externalities.
• External effects of production vs. consumption.
• Vertical vs. horizontal externalities.
• Technological vs. pecuniary externalities.
• Direct vs. indirect externalities.
• Psychological externalities.

Lake Example

• The table outlines relationships between water pollution, chemical production, fishing, and welfare.
• Water Pollution (in tons) vs Profit from Chemical Production (C) vs Profit from Fishing (F) vs Additional Profit for C vs Additional Cost for F vs Social Welfare
• 0 tons vs 0 vs 1050 vs - vs - vs 1050
• 5 tons vs -100 vs 1000 vs -100 vs 50 vs 900
• 10 tons vs 0 vs 900 vs 100 vs 100 vs 900
• 15 tons vs 200 vs 780 vs 200 vs 120 vs 980
• 20 tons vs 500 vs 600 vs 300 vs 180 vs 1100
• 25 tons vs 750 vs 400 vs 250 vs 200 vs 1150
• 30 tons vs 930 vs 170 vs 180 vs 230 vs 1100
• 35 tons vs 1050 vs -100 vs 120 vs 270 vs 950
• 40 tons vs 1100 vs -450 vs 50 vs 350 vs 650
• Questions include scenarios about the lake's ownership, filter installation, and cost-benefit analysis.

The Coase Theorem

• Externalities involve two parties; one party alone cannot create one.
• The cost-by-cause principle is ambiguous.
• Market failure occurs if transaction costs are high (Coase Theorem).

Property Rights Approach

• Increased transaction costs lead to nonmarket mechanisms.
• Government intervention is not always needed if transaction costs are high. Not every externality needs to be removed by Government intervention.
• A Pareto efficient allocation occurs even without government intervention if transaction costs are negligible.

Property Rights and Efficiency

• Distribution of property rights impacts rent distribution, not efficiency if transaction costs are negligible.

Costs that are Important for Economic Policy Making

• Information costs.
• Bargaining and decision costs.
• Monitoring and control costs.

Tragedy of the Commons

• Common pool resources: Exclusion is difficult, and use is rival.
• Ocean fishing, greenhouse emissions, and rush hour traffic are examples.

Fishing Example: Impact of Boats on Profit

• Number of boats vs Value of landed fish (€) vs Marginal revenue of next boat (€) vs Average revenue per boat (€) vs Total Profit (with boat cost of 7000 (€))
• 0 vs 0 vs 15000 vs 0 vs 0
• 1 vs 15000 vs 15000 vs 15000 vs 8000
• 2 vs 30000 vs 15000 vs 15000 vs 16000
• 3 vs 45000 vs 15000 vs 15000 vs 24000
• 4 vs 60000 vs 12000 vs 15000 vs 32000
• 5 vs 72000 vs 10000 vs 14400 vs 37000
• 6 vs 82000 vs 8000 vs 13667 vs 40000
• 7 vs 90000 vs 6000 vs 12857 vs 41000
• 8 vs 96000 vs 4000 vs 12000 vs 40000
• 9 vs 100000 vs 2000 vs 11111 vs 37000
• 10 vs 102000 vs 0 vs 10200 vs 32000
• 11 vs 102000 vs 0 vs 9273 vs 25000
• 12 vs 102000 vs 0 vs 8500 vs 18000
• 13 vs 102000 vs 0 vs 7846 vs 11000
• 14 vs 102000 vs 0 vs 7286 vs 4000
• 15 vs 102000 vs 0 vs 6800 vs -3000

Government Interventions

• Moral suasion.
• Provision by government.
• Coalition of affected individuals.
• Direct regulation (orders and prohibitions).