Detrimental externalities , pollution rights , and the “ Coase theorem ”

This paper, which builds on Chipman (The economist’s vision. Essays in modern economic perspectives, 131–162, 1998), analyzes a simple model formulated by Hurwicz (Jpn World Econ 7:49–74, 1995) of two agents—a polluter and a pollutee—and two commodities: “money” (standing for an exchangeable private good desired by both agents) and “pollution” (a public commodity desired by the polluter but undesired by the pollutee). There is also a government that issues legal rights to the two agents to emit a certain amount of pollution, which can be bought and sold with money. It is assumed that both agents act as price-takers in the market for pollution rights, so that competitive equilibrium is possible. The “Coase theorem” (so-called by Stigler (The theory of price, 1966) asserts that the equilibrium amount of pollution is independent of the allocation of pollution rights. A sufficient condition for this was (in another context) obtained by Edgeworth (Giorn Econ 2:233–245, 1891), namely that preferences of the two agents be “parallel” in the money commodity, whose marginal utility is constant. Hurwicz (Jpn World Econ 7:49–74, 1995) argued that this parallelism is also necessary. This paper, which provides an exposition of the problem, raises some questions about this result and provides an alternative necessary and sufficient condition. This paper is dedicated to the memory of our esteemed respective former colleague and former thesis advisor Leonid Hurwicz. We greatly regret not having been able to discuss the final section with him before his death. Thanks are due to Augustine Mok for his help with the diagrams. J. S. Chipman (B) Department of Economics, University of Minnesota, 4-101 Hanson Hall, 1925 4th Street South, Minneapolis, MN 55455, USA e-mail: [email protected] G. Tian Department of Economics, Texas A & M University, College Station, TX 77843, USA e-mail: [email protected]