Question

Question 5 (1 point) Some of the mangos from your neighbor's mango tree drop into your yard. You don't like mangos and the fallen mangos make it harder to mow your lawn. Your neighbor values the tree at $300, and your cost of dealing with it is $500. If your neighbor has the legal right to keep the tree, what would be an efficient outcome according to the Coase theorem? a) You pay your neighbor $400 to cut the tree down. b) You call city officials to have the tree cut down. c) Your neighbor pays you $400 to not have the tree cut down. d) Your neighbor pays you $200 to not have the tree cut down.

Answer 1

This is the case of a negative externality which the mango tree is greeting for the neighbour in whose lawn the mangoes fall.

The value of the tree to the neighbour (owner of the tree)= $300

My cost of dealing with the fallen mangoes= $500

Using Coase Theorem here,

The legal right to keep the tree exists with my neighbour. So I cannot call City officials to have the tree cut down.

Now my cost of dealing with the fallen mangoes is greater than the neighbour's valuation of the tree.

My never cannot pay me $400 to not have the tree cut down because his valuation of a tree is less than that. Moreover, he need to pay me at all because he has the legal right with him to have the tree.

If neighbour pays me $200 not to have the tree cut down, still I am not going to cover all of my costs. So this option is also not feasible.

But I can pay my neighbour $400 to cut the tree down. It is a Win-Win situation for both of us as the amount of $400 is above his valuation of a tree. It's a good deal for my neighbour. Moreover, it now only costs me $400 to deal with the fallen mangoes instead of $500. So this option will be beneficial for me too.

Hence, the efficient outcome according to the Coase theorem is that it you pay your neighbour $400 to cut the tree down.

Therefore, option a is correct