Coase Theorem and Externalities Quiz

Coase Theorem and Externalities

• Coase theorem emphasizes the role of bargaining in addressing externalities, assuming low transaction costs and well-defined property rights.
• Efficient outcomes can be reached through negotiation, regardless of liability assignment.
• A rancher and farmer can negotiate herd size to mitigate crop damage, achieving an efficient outcome (h* = 3) despite liability issues.
• Without liability, the rancher tends to overstock (h = 4), necessitating government intervention like taxation or legal suits to internalize external costs.

Implications of the Coase Theorem

• Suggests efficiency can coexist with distributional justice.
• Changes in liability assignment affect wealth distribution but not resource allocation.
• Judges can pursue justice without sacrificing efficiency in low transaction cost contexts.
• Flexibility in legal rules becomes important in high transaction cost scenarios to achieve efficiency.

Law and Economics Interplay

• Primary legal sources in the US include the Constitution, legislature, and judiciary.
• Common law, arising from judicial decisions, has market-like properties relevant for economic analysis.
• Understanding the interaction between law and economics aids in evaluating legal frameworks and their economic impacts.

Game Theory Insights

• Game theory examines strategic interactions impacting individual or group outcomes based on mutual decisions.
• Models interdependent decision-making involving individuals, firms, or nations, often highlighting conflict.
• It assists in understanding legal rules and institutions, focusing on players and their strategies.

Public Goods and Policy Solutions

• Public goods face under-provision due to the free-rider problem; private firms struggle to supply adequate levels.
• Government subsidies can support private provision of public goods, e.g., funding research in basic science.
• Direct government provision of public goods, typically funded by taxation, ensures adequate supply (e.g., national defense).

Informational Asymmetries

• Informational asymmetries arise when one party holds superior information, disrupting market efficiency.
• Common examples include car sales and bank agreements, where sellers have more information than buyers.
• Buyers may overpay or avoid purchases if unaware of latent defects in products, necessitating government intervention like mandatory disclosures.

Pareto Improvements and Legal Efficiency

• Pareto efficiency promotes changes where at least one individual benefits without harming others.
• Focuses on balancing precaution costs with potential damages in the context of legal liability frameworks.
• The socially efficient level of precaution is that which minimizes total costs across society.

Unilateral Care Model (UCM)

• UCM assesses the investment in precaution (x) against the probability of accidents (p(x)) and potential damages (D(x)).
• Higher precaution levels reduce accident likelihood but involve diminishing returns on expected damages.
• The social optimum minimizes the total costs of precaution and expected damages.

Care Choice under Different Liability Rules

• Different legal standards (no liability, strict liability, negligence) influence how injurers decide on precaution levels.
• Injurers face inefficiencies based on their care costs relative to the imposed standards (too little care or excess investment).
• Over-investment in care can lead to increased social costs, while under-investment can compromise safety.

Reasonable Person Standard

• A mixed group of injurers may underinvest, overinvest, or invest efficiently, but negligence standards can misclassify them.
• Overall, rigid standards can lead to total societal costs being higher due to uneven care investment across injurers.