Case Study No.

3
Course: Microeconomics Student name:
(Econ-101) AISHA ALHILAL
Academic Year:1440-1441 H Student ID:
180103558

Semester: 1st Student grade: /20

CRN:11319 Level of the marks:

Instructions:

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CASE STUDY 3 : SMOKING AT IKE’S BAR-B-Q PIT

By 2013, only 10 states in the U.S. had not issued statewide bans on smoking in any
nongovernment-owned spaces. Ike’s Bar-B-Q Pit is located in a state that allows smoking in
restaurants and bars. Some of Ike’s nonsmoking customers, including some who suffer from
asthma, have petitioned Ike to adopt a no-smoking rule for his restaurant. Upon hearing of the
petition, some of Ike’s other customers complained that they have smoked in Ike’s restaurant for
years and would not patronize the restaurant if the no-smoking rule were adopted. Ike is greatly
concerned because he does not wish to lose business from either his smoking or nonsmoking
customers.

Private Solutions to Externalities: The Coase Theorem

Learning Objective: Discuss the Coase theorem and explain how private bargaining
can lead to economic efficiency in a market with an externality.
Although government intervention may increase economic efficiency in markets where
externalities are present, it is possible for people to find private solutions to the problem of
externalities. Ronald Coase made this argument in a 1960 article. To understand Coase’s
argument, it is important to understand that completely eliminating an externality is usually not
economically efficient.

A. The Economically Efficient Level of Pollution Reduction

The optimal decision is to continue any activity up to the point where the marginal benefit
equals the marginal cost. This applies to reducing pollution just as much as other activities. As
pollution declines, society benefits, but the marginal benefit from eliminating another unit of
pollution declines as emissions are reduced. As pollution declines, the marginal cost of further
reductions rises. The net benefit to society from reducing pollution is equal to the difference
between the benefit of reducing pollution and the cost. To maximize the net benefit to society,
any type of pollution should be reduced to the point where the marginal benefit from another
ton of reduction is equal to the marginal cost.

B. The Basis for Private Solutions to Externalities

In arguing that private solutions to the problem of externalities were possible, Ronald Coase
emphasized that when more than the optimal level of pollution is occurring, the benefits from
reducing the pollution to the optimal level are greater than the costs.

C. Do Property Rights Matter?

Ronald Coase pointed out that the amount of pollution reduction will be the same whether
polluters or the victims of pollution are legally liable for damages. Bargaining between the
parties will result in the same reduction in pollution, where the marginal benefit of the last
unit of reduction is equal to the marginal cost.

D. The Problem of Transactions Costs

There are frequently practical difficulties in the way of a private solution to the problem of
externalities. For example, if many people suffer from the negative effects of pollution, bringing
all the victims together with all the producers of the pollution to negotiate an agreement often
fails due to high transactions costs. Transactions costs are the costs in time and other resources
that parties incur in the process of agreeing to and carrying out an exchange of goods or
services.

E. The Coase Theorem

The Coase theorem is the argument of economist Ronald Coase that if transactions costs are
low, private bargaining will result in an efficient solution to the problem of externalities. Private
bargaining is most likely to reach an efficient outcome when the number of bargaining parties is
small and all parties are willing to accept a reasonable agreement.
Because Ike’s restaurant is not in a state that regulates smoking in public places, Ike decides to
meet with his smoking and nonsmoking customers to accommodate both of their wishes
regarding his smoking policy.

1) Draw a graph illustrating the externality associated with smoking in Ike’s Bar-B-Q Pit

2) Explain how this externality causes a deviation from economic efficiency in this market.

3) Do you think the Coase Theorem applies to this case?

4) Suggest a solution that would be consistent with the Coase theorem, that is a solution that
would enhance the well-being of Ike’s customers and increase economic efficiency.

Answers:

1)
2)The greater part of the designs currently communicated comprise a very stylish economic
supposition: expressly, that affiliation divisions are splendidly compelling. This adjusted into
actual inside the Ricardian version, the Heckscher-Ohlin model, the exact element interpretation,
and the complete issue of the incomplete concordance exams of alternate and residential
recommendations the utilization of deliver and interface with for twists particularly broadcasts.
The excellent deviation from terrific limitation grow to be in the buying and selling of
economies-of-scale styles and monopolistic important. This is basic due to the reality almost the
whole thing of the effects in regards to the effects of improvement and alternate settles on a
decision envision that enterprise segments are wonderfully commanding. Regardless, what in the
event that they are now not the slightest bit once more?

Equalization association. For elegant, within the actual round the world, being in "security"
additionally can be a tremendous strength.

Responses of financial conviction near to those lines, at any rate, forget about to check the way
in which that cash related exam includes of numerous tries to pursue commercial enterprise
cognizance substances. In spite of reality that it remains intense to exemplify numerous
complexities on a comparable time, it's miles practicable to test them in a piecemeal manner: in a
everyday advancement.
The wide expressions monetary government use to make clear the ones complexities are
enterprise enterprise center imperfections, or marketplace failures, and commercial enterprise
middle turns. These fashions are meriting take a look at due to the fact of the state of affairs it's
miles easy that business challenge parts no longer robotically satisfy the complete thing of the
assumptions made beneath high-quality breaking factor. These sporting events provide
persuading disputes for wellbeing, collectively with the baby commercial enterprise task
competition, the correct duty limit, key exchange incorporation conflicts, and disputes with
reference to national assurance.

Market flaws or market bendings, typically, are any deviations from the assumptions of
wonderful check. These encompass executing enterprise boss model and oligopoly grandstands,
look with creating comes decline once more proportional, promotes that do not spotless, lousy
and no longer too terrible externalities in progress and confirmation, and the closeness of open
issues.

Around the section. For instance, obligations finished with the manual of using a chunk u . S .
Inside the closeness of domestic distortions can every now and then improve country wide
welfare.

Three) Yes because of the truth:

The Coase Theorem battles that below the excellent sensible occurrences sporting activities to a
warfare of phrases roughly assets rights can likewise have the choice to installation a monetarily
maximum fitting solution, paying little heed to the basic scattering of the items rights.

The Coase Theorem offers a really productive way to maintain up below on the best factor of the
want posting a way to eminent fix conflicts among combating enterprise or unmistakable money
associated livelihoods of controlled belongings.

All through and huge for the Coase Theorem to utilize in all likelihood, the situations of
unpracticed, commanding markets, and uncommonly zero trades costs, want to preserve up.

Four) When appeared with an externality, the indistinct herbal ultimate impacts might be come to
without an management intercession as long as the following doubts comfy.
Doubts:

1. Property rights should be in fact described

2. There want to be resulting to 0 trades charges

Viability and invariance

Since Ronald Coase did no longer toward the start inspire to present each person valid principle,
it has in huge thing been the endeavor of different human beings who have driven the indifferent
portions of the Coase speculation. What Coase anyhow gave have grow to be gas as "irrational
notion"[3] that externalities persistently remembered for additonal of a single expo worried about
conflicting games and have to be managed as a corresponding hassle. His work of workmanship
explored the connection a part of the get-togethers and their conflicting video games and the
situation of consigned rights/liabilities. While the affordable which techniques for the Coase
hypothesis stays disappointed, there are issues or claims within the concept: the outcomes can be
capable and the outcomes in articulations of loved gainful useful resource aspect might be the
equal paying little notice to primary assignments of rights/liabilities.

Capability version: other than alternate expenses, the floor-breaking stop result can be
compelling

The zero substitute price scenario is deciphered as that implies that there are not any deterrents to
bargaining. Since any inefficient dissemination leaves unexploited legitimately proscribing
possible impacts, the designation can not be a definitive harmony.

Invariance version: close to alternate expenses, a similar green decisive outcomes will win