Question

One implication of the Coase Theorem (per class discussion) O market failure is the primary cause of most externalities. "everyone is guilty" and that at least some of the "blame" for any of externality falls on all of the parties. a Pigouvian tax is usually the best approach to force internalization of externalities. the party that causes the externality is almost always guilty. QUESTION 12 In our our basic pollution reduction model in Chapter 5, with perfect knowledge a price (tax) and quantity approaches lead to exactly the same outcome. True False

Answer 1

Solution:

First Question:

Coase theorem simply states that if the transaction and bargaining costs are zero, and property rights are defined accurately, any externality can be internalized without authorities' intervention, and an optimal agreement can be reached. Let's look at each of the options carefully and reach the final answer.

Externalities cause market failure, and not the other way around, thus, eliminating this option.

Everyone is not always guilty, however the burden could fall on non-guilty person, if that party doesn't have the property rights (burden, not blame), so eliminating this option.

Pigouvian taxation does involve third party (government) and is contrasting to Coase theories, thus that option is eliminated.

The party that causes the externality is almost always guilty is the correct answer, as that is actually the final result in Coase solution most of the times. Thus, correct option is (d).

Q12. There exists a difference in outcomes from price approach of reducing pollution externality (or abating pollution by taxing pollution production) and the quantity approach (allowing to produce a fixed amount of pollution) only in case of asymmetric information. When the information/knowledge is perfect, the two approaches necessarily give the same outcome, thus, the given statement is true.