Property rights solution to market failure

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Property rights solution to market failure
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Property rights

• Alternative policies can be used to correct for
  market failure
• One option is to recognize the problem as a
  failure to completely specify property rights
• The lack of ownership of a resource means that
  anyone has access to and can make use of the
  resource
• Polluters will use unowned environmental media
  for residual disposal when free to do so

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Property rights

• The set of valid claims to a good or resource
  that permits its use and the transfer of its
  ownership through sale
• Holder can restrict access to and use of
  resources and goods
• Defined and enforced by government
• Rights can be exchanged

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Property rights

• Four categories of property rights systems
• Private property - an individual holds rights of
  access and use
• State property a unit of government controls
  access and use
• Common property a group controls access and
  develops rules for use by members
• Open access no property rights, no restrictions
  on access or use

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Property rights assignment

• Paper pulp mill upstream disposes of residuals
  into river

• Brewery takes water downstream to produce beer
• Needs clean water

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Assigning property rights to solve negative
externality

• Cost of damages
• Brewery cost is 2 million to install water
  purification equipment
• Alternative is to install pollution reduction
  equipment at the pulp mill to clean the water
  before it reenters the river

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Trading water rights
Right to water owned by Right to water owned by
Cost of cleanup at pulp plant Brewery Pulp plant
lt2 million Holds right, pulp plant cleans up
gt2 million
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Trading water rights
Right to water owned by Right to water owned by
Cost of cleanup at pulp plant Brewery Pulp plant
lt2 million Holds right, pulp plant cleans up Brewery buys right, pulp plant cleans up
gt2 million
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Trading water rights
Right to water owned by Right to water owned by
Cost of cleanup at pulp plant Brewery Pulp plant
lt2 million Holds right, pulp plant cleans up Brewery buys right, pulp plant cleans up
gt2 million Pulp plant buys right, brewery cleans up
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Trading water rights
Right to water owned by Right to water owned by
Cost of cleanup at pulp plant Brewery Pulp plant
lt2 million Brewery holds right, pulp plant cleans up Brewery buys right, pulp plant cleans up
gt2 million Pulp plant buys right, brewery cleans up Pulp plants holds right, brewery cleans up
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The Coase Theorem

• assignment of property rights, even in the
  presence of externalities, will allow bargaining
  such that an efficient solution can be obtained
• an efficient outcome can be achieved regardless
  of which of the affected parties controls the
  property rights

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The Coase Theorem

• Important underlying assumption of this theory
• Transactions are costless
• For this theory to hold in practice, at minimum
  it must be the case that very few individuals are
  involved on each side of the market, else the
  cost of negotiating trades will outweigh the net
  benefits of exchange