ECON 391

Economics of the Environment

Chapter 10
Property Rights and Coase Theorem

Stefania Strantza Summer 2020

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Learning Objectives
1. Examine how the assignment of property rights and
the bargaining between parties can lead to a socially
efficient equilibrium
2. Explain how the gains to each party differ depending
on who has the property rights (starting point)
3. Discuss about the Coase Theorem

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Environmental Policies
• Assignment of property rights is a decentralized
method of internalizing externalities
• Decentralized methods allow the individuals involved
in a case of environmental pollution to work it out
themselves once a set of laws or rights has been
established by regulation

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Environmental Policies
• Environmental regulatory policies such as taxes,
subsidies, and transferable emission permits are less
decentralized because they involve more government
intervention
̶ set tax rates, subsidies, or the number of permits to trade
• However, they still allow economic agents to decide for
themselves how they wish to respond to the policy
̶ for example, how much to reduce emissions

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Environmental Policies
• Environmental standards are a very centralized
policy
• Governments set the emission level and polluters
have no options but to meet the standard or face
penalties for non-compliance

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Simple Example
• There are several industrial plants around the lake
• One is a food-processing plant, and the water of the lake
is an important input in its operation
• The other one is an industrial operation that uses the
lake for waste disposal
• How can the pollution damages suffered by the first firm
be balanced with the abatement costs of the second?

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Simple Example
• There are several industrial plants around the lake
• One is a food-processing plant, and the water of the lake
is an important input in its operation
• The other one is an industrial operation that uses the
lake for waste disposal
• How can the pollution damages suffered by the first firm
be balanced with the abatement costs of the second?

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Property Rights
• Property rights define who has the right to
environmental quality
• The basic issue is whether people have the right to a
particular level of environmental quality or whether
those who discharge wastes can do so freely
• We will talk about the rights to the environment as
“belonging” to the polluter or the pollutee

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Property Rights
• All pollution problems involve costs to both sides
(the polluter and the pollute)
̶ the polluter: the side that must pay to abate
pollution
̶ the pollute: the side that is harmed by pollution

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Property Rights - Example
• A chemical factory discharges waste products into a
river which kill many salmon affecting salmon fishery
• Which one of the two protagonists is really causing
damage, and which is the one suffering damages?

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Property Rights - Example
• We might naturally think that the chemical factory is
the one causing the damage
• But doesn’t the presence of the fishery inflict damages
on the chemical factory because its presence makes it
necessary for the latter to control its emissions?
• The problem: it is not clear who has the initial right to
use the services of the river
̶ who effectively owns the property rights to the river

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Property Rights - Example
• The strongest property right is a private property right
̶ this gives the holder exclusive rights to do what he
wishes with the property owned
• Open access recourses have no private property rights
• To solve the problem of river pollution, therefore, it is
necessary to specify who has the rights of ownership
to the river

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Property Rights - Example
• Questions to ponder:
̶ does it matter who has the property rights to the
environmental resource?
̶ will assignment of rights (“ownership”) to either party
yield a socially efficient equilibrium?
̶ how does this choice affect the level of pollution on
the river?

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Property Rights - Example

• The assignment of
property rights
leads to social
efficiency regardless
of who has the
property rights

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Property Rights - Example

• The assignment of
property rights
leads to social
efficiency regardless
of who has the
property rights

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 The Polluter Holds Property Rights
• If the chemical factory has the
property right to use the river, it will
not abate any of its effluent
̶ E0 tonnes/month is the starting point
• To reduce chemical effluent into the
river, the fishery will bargain with the
factory and offer a payment
• The socially efficient equilibrium can
be reached after bargaining

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 The Pollutee Holds Property Rights
• If the fishery has the property
rights, the starting point is E=0
• If the chemical factory wants to
emit, it will have to bargain with
and compensate the fishery
• The fishery will allow emissions as
long as the payment at least covers
their marginal damages
• This allows the socially efficient
level of pollution to be reached
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Property Rights
• The same socially efficient equilibrium can be
reached independent of who holds the rights to
the river
• Bargaining between the two parties allows each to
benefit by either reducing damages or reducing
abatement costs
• But, the size and distribution of the net gains differ
with the holder of the rights in a stronger position
to receive compensation

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Property Rights
• The same socially efficient equilibrium can be
reached independent of who holds the rights to
the river
• Bargaining between the two parties allows each to
benefit by either reducing damages or reducing
abatement costs
• But, the size and distribution of the net gains differ
with the holder of the rights in a stronger position
to receive compensation

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Property Rights
• The same socially efficient equilibrium can be
reached independent of who holds the rights to
the river
• Bargaining between the two parties allows each to
benefit by either reducing damages or reducing
abatement costs
• But, the size and distribution of the net gains differ
with the holder of the rights in a stronger position
to receive compensation

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Coase Theorem
• The socially efficient level of pollution can be reached
regardless of the assignment of the property rights
• Net gains to each party differ depending on who has
the property rights to environmental resources
• Net social gains are dependent on who has the
property rights to environmental resources

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Coase Theorem
• The socially efficient level of pollution can be reached
regardless of the assignment of the property rights
• Net gains to each party differ depending on who has
the property rights to environmental resources
• Net social gains are dependent on who has the
property rights to environmental resources

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Coase Theorem
• The socially efficient level of pollution can be reached
regardless of the assignment of the property rights
• Net gains to each party differ depending on who has
the property rights to environmental resources
• Net social gains are dependent on who has the
property rights to environmental resources

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Coase Theorem
• The socially efficient level of pollution can be reached
regardless of the assignment of the property rights
• Net gains to each party differ depending on who has
the property rights to environmental resources
• Net social gains are dependent on who has the
property rights to environmental resources

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Application of Property Rights
• How well is the property rights policy likely to work
in practice?
• A property right must be well defined, enforceable
and transferable

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Application of Property Rights
• How well is the property rights policy likely to work
in practice?
• A property right must be well defined, enforceable
and transferable

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Problems with Property Rights
• They can suffer from transactions costs in the form
of negotiating costs and costs of enforcement
̶ the more people involved, the more difficult it is to
negotiate a solution
• Open access and free riders
̶ the socially efficient equilibrium many not be
achieved through property rights assignments and
bargaining

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Problems with Property Rights
• They can suffer from transactions costs in the form
of negotiating costs and costs of enforcement
̶ the more people involved, the more difficult it is to
negotiate a solution
• Open access and free riders
̶ the socially efficient equilibrium many not be
achieved through property rights assignments and
bargaining

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Problems with Property Rights
• They can suffer from transactions costs in the form
of negotiating costs and costs of enforcement
̶ the more people involved, the more difficult it is to
negotiate a solution
• Open access and free riders
̶ the socially efficient equilibrium many not be
achieved through property rights assignments and
bargaining

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Overview
• Studied a policy of decentralized approach to
environmental quality improvement
• Allocation of property rights
̶ private bargaining and challenges associated with
reaching social efficiency

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