Coase Colored Glasses

Archive for January 16th, 2011

Dealing with Externalities

This week’s reading has brought me back to our soon to be good friend, Coase. The more I read his theory, the more I wonder how badly we really want the most efficient outcome. Yes, we may achieve an efficient outcome. However, is it truly the most efficient? And if it is the most efficient, does that include long term efficiency? Let’s look at the example of the polluted factory, provided by Friedman. Friedman’s example states that the pollution creates $60,000 worth of damages per year, pollution control costs $80,000 per year, and that switching the land use downwind of the factory would cost $100,000 per year. If the EPA were to charge a $60,000 fine for the pollution, the fine would be less than the cost to control pollution and the factory would continue on with business as usual. This also leaves means that the inhabitants downwind form the factory must deal with $60,000 in damages without any compensation, unless they are willing to assist the factory in paying to control pollution. But this seems like a very simplified version of all the potential options.

If we ignore the downwind inhabitants for a moment, we are left with the factory and the fine from the EPA. As I previously mentioned, the fine is less than the cost to control the pollution, which gives the factory reason to continue on with business as usual. But what if the factory could find a way to control pollution for $100,000 every two years? Then things would change. In this hypothetical situation, the factory could install a pollution filtration system for less than the fines the factory would incur over the same period of time ($160,000). Many of the pollution control options that factories have at their disposal today can have a high start up cost, but would end up costing less over a long period of time than a yearly fine would cost. The example provided by Friedman gives us an efficient result, but other options available would end up being much more efficient while still achieving the same ends.