The Problem of Social Cost Pt. 3

Coase's Concerns

• Shows weaknesses in the traditional Pigou-type of analysis.
• Explains externalities are reciprocal.
• Highlights the importance of transaction costs in economic analysis.
• Advocates a fundamental change in economics approach.

External Effects

• Arise when actions of an individual or organization impact another without full compensation.
• There are negative effects when one party’s actions create costs or disutility for others, potentially without compensating them.
• Positive ones happen when actions create utility for others, without being fully compensated.
• Consequences of personal actions are not always considered in decisions.
• These occur because property rights are poorly defined or enforcement costs are too high (Coase, 1960).
• Examples include environmental pollution, smoking, vaccination, monopoly pricing, and network externalities.

Private vs Social Costs and Benefits

• Private Surplus = Private Returns - Private Costs
• External Surplus = External Returns - External Costs
• Social Surplus = Social Returns - Social Costs

Types of Externalities

• Positive vs. negative
• Production vs. consumption
• Vertical vs. horizontal
• Technological vs. pecuniary
• Direct vs. indirect
• Psychological

Lake Example

• The table shows a sample calculation of social welfare as pollution increases in a lake.
• It also includes the profit of chemical production, and the profit the fishing industry gains.
• A series of questions relating to the impact of liability are posed.

The Coase Theorem

• Externalities always involve two parties.
• The cost-by-cause principle is often ambiguous.
• Market failure through externalities occurs when transaction costs are high.
• Increased transaction costs organize exchange through nonmarket mechanisms.
• Significant transaction costs make it costly to remove externalities.
• Government intervention is not always needed.
• Negligible transaction costs lead to a Pareto efficient allocation without government intervention, independently of property rights distribution.

Internalizing External Costs

• With negotiations, it's possible to internalize external costs if the polluter is liable for damages.
• With negotiations, it's possible to internalize external costs even if the polluter is not liable for damages.

The Tragedy of the Commons

• The distribution of property rights affects rent distribution, but not efficiency, if transaction costs are low.
• Transaction costs are often not negligible regarding policy, and they include information, bargaining, decision, and monitoring costs.
• Tragedy of the Commons describes pool resources, where exclusion is difficult, and usage is rival.
• Examples are ocean fishing, greenhouse emissions, and rush hour traffic.

Fishing Example

• Calculations for the ideal number of boats is explored with data from 1-15 boats.
• Revenue, costs, and profit is calculated.

Government Interventions

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