0:12
Let's begin this module where we ended the last module,
 with a quick look at the following table.
 As you can see most obviously from the table,
 there are many ways to correct market failures,
 or subtly however the solutions are different in
 some ways for handling negative versus positive externalities.
 For example, Pigouvian taxes can be used to address
 negative externalities while Pigouvian subsidies are favored for positive externalities.
 Let's work our way now through this list starting with
 the idea the government might not be needed at all.
 An idea embedded in a famous key concept known as
 The Coase Theorem which advocates the use of bargaining to address externalities.
 The Coase Theorem was
 conceived by University of Chicago professor and Nobel laureate Ronald Coase.
 Coase argued that negative or positive externalities do
 not require government intervention when, one,
 property ownership is clearly defined, two,
 the number of people involved is small,
 and three, bargaining costs are negligible.
 To see this, suppose a fictional character, not coincidentally,
 named John Tanner owns a tannery
 in a very small town with a population of just 100 people.
 And suppose further that in addition to producing
 beautiful leather for Louis Vuitton handbags,
 the tannery stinks to high heaven.
 It just smells awful to the townspeople.
 So what do you think a Coase bargaining solution would look like in this case?
 Take a few minutes to think about this and jot down
 some ideas about the possible bargain as we pause the presentation.
 And here is a slightly harder question too,
 what more information do you need to actually come
 to a complete answer?
 Well, in order for the Coase style private bargaining to work,
 we need to first assign property rights.
 So to begin, let's assume John Tanner has the property rights,
 meaning that his tannery can stink up as
 much of the air around the town as John Tanner wants.
 How might a Coase bargain be achieved under
 this assumption between Mr Tanner and the townspeople?
 Again, think about this for a minute and jot
 down some ideas as we pause the presentation.
 3:15
Well, the Coase Theorem predicts that the townspeople
 might offer to pay John Tanner to reduce his output,
 or alternatively, simply buy the tannery and shut it down.
 As for how much the townspeople might be willing to pay John Tanner,
 that amount will depend on how much profits his plant generates,
 how much the townspeople value eliminating the discomfort caused
 by the tannery and how well each side negotiates.
 And if the value the townspeople assigns sign
 to eliminating their discomfort is more than Mr.Tanner's profits,
 the two parties may well come to some bargain.
 So do you see how this might work?
 But now, let's switch property rights.
 Let's say that your group owns the rights to the air and the only way Mr. Tanner can
 produce leather is to purchase
 those rights from the townspeople and therefore the right to pollute.
 What will the Coase Theorem predict here?
 Again, let's pause as you jot down some ideas about the likely Coase bargain.
 5:24
Well, most of you would probably say that the townspeople should
 have the right to clean air just as a matter of fairness.
 But suppose I told you that the tannery was there
 long before the citizens now are complaining,
 would that make a difference?
 That is indeed some food for thought.
 The other thing that is interesting about this example is how
 quickly any possibility of a bargain breaks down,
 particularly if it is the town members who are
 expected to compensate the tanner for shutting down the factory.
 Here, some people may be bothered more than others by
 the stench and some may not be bothered at all.
 Should everyone pay the same amount to the tanner?
 Should only those who are bothered pay?
 And recalling our old friend the free rider
 problem that plagues the provision of public goods,
 how can we tell if people are telling
 the truth about how much the stench actually bothers them,
 particularly if their payment will depend on their answer?
 And here is the punchline,
 because Coase bargaining is so difficult and limited,
 there are many other ways the government may intervene
 to deal with externalities.
 One other such remedy to do what economists refer to as internalizing externalities,
 is to rely upon a legal framework of liability laws.
 This framework is known in legal circles as the Wrongful Act or Tort System.
 And the idea behind Torts is that the person or corporation that produces
 the negative externality is legally liable for any costs or damages to other persons.
 For example, suppose the Ajax degreaser company regularly dumps
 leaky barrels of solvents into a nearby canyon owned by the Barbeque Ranch.
 Once the Barbeque Ranch discovers the pollution,
 it then can file a lawsuit against Ajax degreaser to
 collect for the pollution damages as well as the costs of a possible cleanup.
 However, as with the Coase theorem,
 this Tort system has its limitations.
 For one thing lawsuits are expensive,
 time consuming and have
 uncertain outcomes while major time delays in the court system are commonplace.
 In addition there is great uncertainty.
 Will the court or jury accept your claim that your child's leukemia
 has resulted from the toxic waste emitted by the degreaser plant next door?
 Can you prove that a specific firm in
 the area is the source of the contamination of your well?
 And, are you willing to risk all of your money to sue a deep pocketed corporation
 with hundreds of millions of dollars in assets and a team of 50 lawyers?
 It is precisely these kinds of constraints and observations that lead
 us to yet another approach to internalizing externalities.
 Direct government intervention in the form of either command and control
 regulation or the use of Pigouvian taxes and subsidies to modify behavior.
 And that's the subject of our next module.
 So when you are ready, let' s move on.
 
Dr. Peter NavarroProfessor
