Question

Consider how or if the Coase Theorem can be applied to the following scenarios.

(i.) My neighbor wants me to cut down an ugly shrub in my front yard. The ugly shrub imposes an external cost on her and on her property value.

(ii.) A coal-red plant dumps its leftover hot water into the nearby lake, killing the naturally occurring fish. Hundreds of homes line the banks of the lake.

(iii.) A coal-red plant dumps its leftover hot water into the nearby river, killing the naturally occurring fish downstream. A number of locals who fish on the same river are affected by this.

Answer 1

According to coase theorem , if property rights can be identified and transaction costs are zero then socially optimal solution can be reached incase of externality

I ) This is a case of negative externality. Coase theorem can be applied as property rights can be identified ( shrub belongs to the owner) so here the neighbour can pay the shrub owner  to cut down the shrub such that the payment exceeds the damage done from the loss of tree to the owner

or the owner can pay the neighbour some amount to accept the shrub as it is . The neighbour will accept the payment if it exceeds loss from her fall in property value because of that shrub.

2 ) In this case coase theorem cannot be applied as leftover dumped in the river are not affecting the lives of people living near the river . The question does not mention that people living near river are getting affected by the leftovers so not a case of externality .

3 ) Yes in this case coase theorem can be applied as both the parties to transaction can be identified . This is a case of native externality where the leftovers hurt the people living along the river .

Coase theorem would involve that the plant makes a payment to the people living along the river such that people are willing to accept some amount of leftovers. The payment made by firm would increase the cost of production for the plant causing it produce socially optimal level of output .

Or the people could pay the plant to reduce their output such that the firm would accept the payment if payment exceeds the loss of profits from reducing the output.