Answer to Question #154060 in Macroeconomics for Kiti kgare

Question

Explain Coase theorem in detail

Answer 1

If property rights are clearly defined and transaction costs are zero, then resource allocation (production structure) will remain constant and efficient regardless of changes in the distribution of property rights.

Consider two businesses in the neighborhood - a candy factory (without external influences such as a chimney) and a dentist who occupies an adjacent room. They coexist peacefully, with a profit: the dentist is $ 600, and the factory is $ 200. And then the factory decides to upgrade and start a new kneading machine, which will give them + $ 200 profit. We get, the factory's profit is now $ 400 (versus $ 600 for the dentist).

But here's the trouble. The dentist began to leave clients because of the noise from the new car, he began to lose profit, and now earns only $ 300. What he does is he offers the factory a $ 200 rebate to keep them from turning on their new wonder machine. The owner of the factory still stays with his own people, so he agrees to such a deal. (here we recall that the theorem assumes the absence of taxes and additional costs for such a transaction, that is, black cash in words)

We get the dentist now has $ 400 (600-200), which is more than the $ 300. And the owner of the factory has $ 400 (which he planned to have when bringing in a new car).