If T were to decide production, it would choose to produce no oil. Exxon would not be happy
with that arrangement, and so it may negotiate to pay Ocean Tours anywhere between area D and
areas D + C to produce oil at an efficient production level.
- In other words, T will only choose to allow production if paid at least the cost of
pollution (D), while the maximum R would pay is its total benefit from producing oil
(D+C). They can negotiate to some value between B+A and A
Note that efficiency here refers to production at the socially optimum level, where marginal social
cost (MSC) equals the marginal social benefit (MSB) of production. Any other level would cause
dead-weight loss, where MSC is different than MSB, and society would benefit from a change in
production. In these cases, dead weight loss would be area A if the Oil Rig doesn’t reduce oil
production, or C if the Coral Tour doesn’t allow oil production. These areas are where MSC is
higher or lower than MSB.
Three reasons can explain why the Coase Theorem doesn’t always work.
1. Transaction Costs: if they cost more than the potential benefits of negotiation.
2. Bargaining Breakdowns: negotiations fall through
3. Ill-defined Property Rights: who pays who? This also results in bargaining breakdown.
Market failure also occurs when dealing with non-rivalrous and non-excludable goods.
When one person’s consumption of a good leaves it unavailable to others, it is considered
Rivalrous Consumption. TV is an example of a non-rivalrous good, where I can watch TV
without stopping you from watching.
When people can be prevented from consuming a good, it is considered Excludable
Consumption. These goods are in a sense privileges, and people can be charged to gain that
privilege. A non-excludable good would be a public park, which is free for everybody to enjoy.
Private Goods: usual consumption goods and services. Take a banana: it is rivalrous because
once you eat it, no one else can. And a banana is excludable, because to be able to enjoy it you
have to buy it.
Local Public Goods and Club Goods: like Internet service, cable TV, concerts, and fitness
clubs. When uncongested, these are non-rivalrous. However, they are excludable because
consumers still must pay to take part.
Common Property Resources: like congested roads and bridges, fisheries, air and water.
Congested roads, for example, are free to enter by anyone. But you must compete with other cars
to find space.
These tend to result in a “tragedy of the commons”, be overused by the market, resulting where
resources are depleted. Fisheries are good examples. While a sustainable level of fishing may be
at maximum profits (where marginal product equals the workers’ wage), fishermen will enter the