2. (10) The Coase Theorem (This is a modified version of the James Meade example

Question

2. (10) The Coase Theorem (This is a modified version of the James Meade example referred to in the book.) A beekeeper and the owner of an orange orchard have a synergistic relationship. The beekeeper benefits from putting his beehives in the orchard since his bees make honey from the orange blossom pollen. The orchard owner benefits from having the beehives in his orchard since the bees pollinate his trees. There is a reciprocal positive externality. The table below gives the profit of the beekeeper and the orchard owner as a function of the number of beehives that the beekeeper places in the orchard, before any transfer between them.

a) (1)   What is the efficient number of beehives to have in the orchard?

Assume that the above table is common knowledge to both the orchard and beekeeper, that bargaining is costless, and that there are no other orchards or beehive owners.

b) (3)   Suppose that the orchard owner has property rights to his orchard, so that the beekeeper has to obtain the orchard owner’s permission to put his beehives in the orchard. What is the equilibrium number of beehives in the orchard? How much will the orchard owner charge to have the beehives in his orchard? Is the equilibrium efficient?

c) (3)    Suppose that the beekeeper has the property right to place his beehives in the orchard. What is the equilibrium number of beehives in the orchard? How much will the orchard owner pay the beekeeper? Is the equilibrium efficient?

d) (2)   State the Coase Theorem.

e) (1)   Are the outcomes of the above example consistent with the Theorem?

Explanation / Answer

1) Coase Theorem is the proposition that in the absence of transactions cost the level of production of goods or services in an industry in which there are externalities is independent of whether or not the party who perpetrates negative externalities is legally liable for the costs of the externalities on other parties.

In the above table it is quite clear that socially optimal output is achieved at 4 beehives. At this point output is 14.5

2) If the orchard has the property right then he is will have to be compansated and in this case optimal rent would be 3.25 which will still give socially optimal output.

3) In the case of Bee Keeper, Orchard will try to maximize output at 6 or 7.

At this point bee keeper is having minimal benefit and will charge 4 but this will not be optimal production socially and will not be at equilibrium.

4) COASE THEOREM

Coase Theorem (Part I)

When there are well-dened property rights and costless bargaining, then negotiations between the party creating the externality and the party aected by the externality can bring about the socially optimal market quantity.

Coase Theorem (Part II)

The ecient solution to an externality does not depend on which party is assigned the property

rights, as long as someone is assigned those rights

e) Yes,outcomes seems to be consistent with Coase theorem.

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