Question

The issue of negative externalities cannot be resolved until what is clearly defined? Select one: a. The faulty party b. The cost to society c. Property rights d. Equilibrium price and quantity

Answer 1

Option C. Property rights

Property rights determines whether a particular scare good belongs to an individual and it is the duty of the government to enforce property rights. According to Coase theorem, when Property rights are not clearly defined, it leads to market failure. Market failure is a situation in which the market left on its own (.i.e when there is no government intervention and only the invisible hand operates) fails to produce and allocate resources efficiently. For this reason, the government should intervene in the economy to promote efficiency and equality in the society and also also remove negative externality.

Negative Externality - Lets use the graph to explain a negative externality.

The Marginal Social Benefit curve shows how much an individual benefits from additional units of a good consumed. The Marginal Social Cost is the cost of producing the good plus the additional cost to the society as a whole. Here Q is the optimal quantity, but in a market without government intervention, the society produces at a point larger than the optimal quantity. This leads in a deadweight loss as shown by the shaded region.

Now Coase Theorem says that if there is negligible transaction cost involved, there will be an efficient outcome. For example, lets say a group of people are polluting a lake nearby by washing clothes, throwing plastics, etc which is resulting to the deaths of fishes in the lake and fishermen are getting affected. Now if the government imposes a property right of the lake to fishermen, for example, then the group of people now have to negotiate with the fishermen and give them incentives such as money to continue their daily chores. It can also happen that if the government imposes a property right to the group of people then the fishermen in turn has to negotiate and give them incentive to pollute less so that they can continue fishing in the lake.