Question

6. Exercise 16.8 Suppose a sheep rancher leases the mineral rights beneath her grazing land to an oil company. Because she fears that discharges from the oil wells will pollute her underground water resources. The contract for the sale of mineral rights requires that the rancher and the oil company reach a mutually agreeable solution to problems of water contamination, should they arise. If such bargaining fails to result in an outcome acceptable to both sides, the mineral rights lease will be terminated automatically, and the rancher will be required to return a portion of the lease proceeds to the oil company. The portion that must be returned to the oil company is to be determined through a process of binding arbitration. According to the Coase theorem, which of the following is the more likely outcome?

Assume that profits generated by the oil company from the lease exceed the rancher’s loss from the water contamination.

a) The two parties successfully negotiate a conclusion acceptable to both sides.

b) The mineral rights lease is terminated, and the rancher returns a portion of the lease proceeds.

Answer 1

According to coase theorem option A is more likely to be the outcome as coase theorem says that under perfect competition and no transaction costs a dispute over property rights amongst two parties will lead to an economically efficient outcome in which the two parties will benefit regardless of the initial distribution of property rights.