COASE THEOREM

 The Nobel Laureate Ronald Coase in 1960 recommended that by assigning property rights
alone we can provide an efficient solution to environmental problem.
 Property rights are the set of valid claims to a resource that permits use of that resources and the
transfer of its ownership through sale.
 According to him any efforts to internalize environmental externalities requires an effective
scheme for assigning property rights.
 In his theory he explains how an arbitrary assignment of property rights can reach at an
optimum solution.
 He explains the process with the examples of an interaction between polluter and pollutee.
 Let there exists a paper mill and a fish hatchery. Here both paper mill and fish hatchery believes
that the nearby river is a common property resources and use according to their own will.
Paper mill discharges its wastes into the water and pollutes the river which may damage the
operation of fish hatchery downstream.
 Thus, paper mill acts as a polluter and fish hatchery is the pollutee. Now how property rights
can be used for optimum level of pollution is explained in the figure below.

MAC

MDC
Marginal Damage/
50
Abatement Cost
45

30 E
RS
20
15

70 110 140 200

 Waste Emission
In the figure MDC shows Marginal Damage Cost (to the hatchery) which is the additional
damage that each unit of pollution makes.
 In the figure, MAC represents Marginal Abatement cost (of paper mill) which is the mitigation
cost of cleaning the mill.
 Now suppose an exclusive property right is given to fish hatchery unit which is the pollutee,
it will withstand the pollution so long as the polluter pays a compensation which is higher than
the damage cost (MDC).
 But the polluter (Paper mill) is willing to offer a compensation which is below the abatement
cost (MAC).
 The result of the bargaining between the two will bring them to the point ‘E’ where OP
pollution is created.
 If on the other hand, initial property right was with the polluter (Paper mill), he would have
to be compensated by the pollutee for reducing the emission.
 The polluter will be willing to abate pollution only if the compensation is greater than his
marginal abatement cost.
 Also the pollutee (Fish hatchery) will be willing to pay a compensation that is below the
marginal damage cost.
 The bargaining, here also, will bring them to point ‘E’ which is a Pareto Optimum. Coase
theorem, thus, shows that optimum solution is independent of the initial distribution of property
rights.
 Coase theorem is based on many assumptions such as,
 Every time (both polluter and pollutee) has perfect information.
 There are no transaction costs
 Economic agents act rationally
 Many criticisms have been raised against Coase Theorem. The real world situation is very much
different from that assumed in the theory. There is no free information, and transaction costs are
high and many times economic agents act irrationally. Thus, property rights cannot act
efficiently in all conditions. Yet, it can act as an effective tool in many situations.
 There are many examples from different countries, where property rights became an efficient
tool in managing common property rights. In India, the forest conservation through tribals
stands as an effective model of forest conservation. Here, rights on forest produces were
exclusively given to tribal community. In return, the tribals safeguard the forest.