Friday, March 5, 2010

The Coase Theorem in Action?

The Coase Theorem states that in the absence of wealth effects, if transactions costs are less than the gains from bargaining and if property rights are clearly assigned, private bargaining can lead to an optimal amount of an externality.

The Financial Times reported on electric generating firms that are paying their customers not to consume electricity during peak demand - typically Summer months. While this is not necessarily an externality - it does have the spirit of the Coase Theorem, in that if the marginal costs to one party (electric generating firms) is greater than the marginal benefits to the other party (electricity consumers), that there are beneficial gains of the two parties getting together and the one with the higher marginal costs, paying the other party to reduce their consumption.

For an example with clear externality issues, read about Indonesian rain forests.

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