ECO320H1 Lecture Notes - Lecture 2: Artichoke, Dune, Price Ceiling

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<Property Rights>
2.8: In the figure 2.15, if the firm is producing output, is there any external cost being
generated? If so, why is this output level called a social optimum? Would it not be optimal
to have NO external cost? At what level of output would that occur? Does our earlier
discussion that characterized any social optimum as the point at which (social) marginal
costs equals (social) marginal benefit provide any guidance? Is the point at which the
existence of some external cost? Why or Why not?
[Explains the important distinction between Private Marginal Cost and Social Marginal
Cost for Property Rights]
- Given the technology used by this frim, external costs will always exist under any positive
level of production. Let’s think of an extreme case: This might be one in with the social
cost of the activity was always above the social benefit. First-degree homicide might be a
good example. The socially optimal amount Is 0 for these cases. But for non-extreme
cases, where there is a range in which the social costs are below the social benefits, a
non-zero amount of activity is socially optimal, while some external costs might be
generated
4.3: Suppose that a railroad runs beside a field in which commercial crops are grown. The
railroad is powered by a steam locomotive that spews hot cinders out of its smokestack.
From time to time those cinders land on the crops nearest to the track and burn them to
the ground. Assume that each year, the farmer whose crops are burned loses $3000 in
profits, and that the annual cost to the railroad of installing and maintaining a spark-
arrester that would prevent any damage to the crops is $1750. Does it matter to the
efficient use of the farmer’s land or the efficient operation of the railroad whether the law
protects the farmer from invasion by sparks or allows the railroad to emit sparks without
liability? Why or Why not?
[Railroad Example]
- If transaction costs are zero, the efficient solution will be reached whether the law
protects the farmer or allows the railroad to emit sparks. However, if the costs of
bargaining are high, then the efficient solution may not necessarily be reached.
4.5: Invariance
With Zero transaction costs, the farmer fences the cornfield rather than the rancher fencing
the ranch regardless of the rule of law. Notice that in this example, the use of fields of
cattle-ranching and corn-growing is the same, regardless of the initial assignment of
property rights. This version of the Coase Theorem = Invariance Version (because the use
of resources is invariant to the assignment of property rights). This version turns out to be
a special case. The more general case is one in which the resource allocation will be
efficient (but not necessarily identical), regardless of the assignment of property rights.
There will be a Pareto-efficient allocation of goods and services, but it may be different
from the Pareto-efficient allocation that would have resulted from assigning that same
entitlement to someone else.
[Explains why identical resource use is a special case of efficient resource use]
4.6: Endowment Effects
An endowment is an initial assignment of ownership rights. The divergence between
buying and selling price is called an endowment effect because the price varies depending
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on the initial assignment of ownership. Why might farmers place a different value on the
right to be free from straying cattle depending on whether they were selling or buying that
right? Is it rational to place different values on those rights? How do these flip-flops in the
relative valuation complicate an efficiency analysis of the assignment of property rights?
[Endowment effects are ignored in the Theorem of Coase but these effects are important
in the emerging area of economics called BE]
- Based on the idea of endowment effects, the farmer who already has the ability to be free
of straying cattle enjoys current benefits and is not willing to give those up (not willing to
"sell" rights of the endowment). A farmer who didn't get the right to be free of straying
cattle in the initial endowment would be willing to pay for the right, but the farmer's price to
buy would be less than what they would charge to sell the right if they already had it.
4.9: Rank the following six transactions from lowest to highest transaction costs. Explain
your ranking by reference to the costs of search, bargaining and enforcement.
a. Getting married
b. Buying an artichoke
c. Acquiring an easement to run a gas line across your neighbour’s property
d. Selling a Burger King franchise
e. Going to college
f. Purchasing a warranty for a new car
[Transaction Costs]
- Low to highest
1. buying an artichoke
2. purchasing a warranty for a new car
3. going to college
4. acquiring an easement to run a gas line across your neighbour’s property
5. selling a Burger King franchise
6. Getting married
정리:
Higher Transaction Costs: unique good / uncertain / many hostile unfamiliar parties / unreasonable behavior /
delayed exchange / numerous contingencies / high costs of monitoring / costly punishments
Lower Transaction Costs: standardized good or service / clear or simple rights / few friendly familiar parties /
reasonable behavior / instantaneous exchange / no contingencies / low costs of monitoring / cheap punishments
4.10: Consider the right to smoke or to be free from smoke in the following situations. In
which situations do you think that TC are so high that they preclude private bargaining
(Normative Hobbes), and which cases do you think that TC are low enough for Private
Bargains to occur?
a. Smoking in a private residence
b. Smoking in a public area, such as a shopping mall, an indoor arena or concert hall, or
an outdoor stadium
c. Smoking in hotel rooms
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d. Smoking on commercial airline flights
- a: No, virtually no transaction costs here
b: Yes, transaction costs are high (public area a lot of people’s interests are at stake)
c: transaction costs are relatively low. Hotel owners generally subject only to local or state
regulation in the US / that country. So hotel proprietors can be relatively quick and flexible
to changing consumer tastes
d: transaction costs are relatively high. Airlines are relatively highly regulated and more
importantly, their normal business has them crossing state lines so that the ability of local
regulators to reach them is attenuated (악화). Realistically speaking, only federal
regulators or the national legislature could have caused the airlines to make their flights
smoke-free. Also, the external cost of smoking is more immediate and less avoidable on
an airplane flight than in other places, like a hotel room.
4.11:
a. when TC are low enough, efficient resource allocation will follow regardless of particular
assignment of property rights. When TC are high enough, efficient resource allocation
requires assigning property rights to the party who values them the most (Normative
Hobbes Theorem). Give and example of each case.
- An example of a low-transaction cost setting might be one in which the issue is the
assignment of a legal entitlement to place a poster on a wall in a rental apartment. Should
the landlord or the tenant have the entitlement to decide whether and how to place a
poster on an interior wall? In some senses it doesn't matter: the cost of negotiating
between the parties are so small that whoever values the entitlement more is likely to
possess it.
- An example of high TC might be the entitlement to hold parade on public streets.
b. can you use the Normative Hobbes Theorem to justify legislation regulating the
collective bargaining process between employers and employee unions?
- It is certainly possible that employers and employees can bargain to a mutually
satisfactory conclusion in their collective bargaining agreement, but there is a significant
chance that they may not. And if they do not, the costs to the parties and to society can be
substantial and ripple through the community. Law might limit the damages that failures to
reach an agreement might cause by giving the government to power to order strikers back
to work or imposing a "cooling off" period. Additionally, competent mediators can help to
bring deadlocked negotiators together and skilled personnel management can seek to
head off these disputes.
c. when people strongly disagree, the may try to harm each other, or they may walk away
from a potentially profitable exchange. What does the Normative Hobbes Theorem
suggest the response of the law should be able to these two possibilities?
- There are direct and indirect methods of responding. Directly, the government might
announce (as it does) that it will punish violence severely. Indirectly, the government can
seek to educate citizens about techniques of bargaining and communication so that they
can be more effective bargainers. As to walking away from otherwise profitable bargains,
this is an example of the Hobbes Theorem. Since Cooter's original insight in "The Cost of
Coase" that there were significant social costs to bargains not completed that would have
been mutually beneficial, we have known that parties sometimes "overreach" - they
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Document Summary

[explains the important distinction between private marginal cost and social marginal. Given the technology used by this frim, external costs will always exist under any positive level of production. Let"s think of an extreme case: this might be one in with the social cost of the activity was always above the social benefit. The socially optimal amount is 0 for these cases. But for non-extreme cases, where there is a range in which the social costs are below the social benefits, a non-zero amount of activity is socially optimal, while some external costs might be generated. 4. 3: suppose that a railroad runs beside a field in which commercial crops are grown. The railroad is powered by a steam locomotive that spews hot cinders out of its smokestack. From time to time those cinders land on the crops nearest to the track and burn them to the ground.

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