For each of the examples below, please answer the following:
a. Does an externality exist? If so, classify the externality as positive/negative (or both).
b. If an externality exists, determine whether the Coase Theorem applies (i.e. is it possible to assign property rights and solve the problem?
c. If it is possible for the Coase Theorem to solve this problem explain how.
Example 1 – ABC Company builds a garbage recycling plant in a low-income area of the city.
Example 2 – Your neighbors (whose apartment is right next door and has thin walls) are big fans of football and they blast their television at all hours watching games.
Sample Answer
Sample Answer
Example 1: a. Yes, an externality exists. The externality in this case is negative, as the garbage recycling plant may produce unpleasant odors, noise pollution, or other negative effects that impact the quality of life for the residents in the low-income area. b. The Coase Theorem may not apply in this case. It may be difficult to assign property rights or negotiate a solution, as the residents of the low-income area may not have the resources or bargaining power to effectively address the issue with the ABC Company. c. If the Coase Theorem were to apply, it would require the ABC Company and the affected residents to negotiate a mutually beneficial agreement. The company could compensate the residents for the negative externalities they experience by providing financial compensation, implementing measures to minimize the negative effects (such as installing air filters or noise insulation), or finding an alternative location for the garbage recycling plant. However, it is important to note that in practice, implementing the Coase Theorem may be challenging in this scenario due to the power imbalances and limited resources of the low-income residents.
Example 2: a. Yes, an externality exists. The externality in this case is negative, as the loud noise from the neighbors’ television impacts your peace and quiet, causing discomfort and potential disturbance. b. The Coase Theorem may apply in this case. It is possible to assign property rights and potentially solve the problem through negotiation between you and your neighbors. c. If the Coase Theorem were to apply, you and your neighbors could establish property rights and negotiate a solution. For example, you could discuss quiet hours during football games or they could invest in soundproofing their apartment to minimize the noise impact on you. By assigning property rights and allowing negotiations, both parties have the opportunity to reach a mutually agreeable solution.
