Question

a) According to the Coase Theorem, why do markets with negative externalities result in overproduction of pollution when producing goods that emit pollutants during the production process?

b) Using the Coase Theorem, what market forces do economists recommend using to correct for the deadweight loss caused by markets with negative externalities?

Answer 1

a). According to Coase theorem, markets with negative externalities result in overproduction of pollution when producing goods that emit pollutants during the production process because firms tend to maximize their economics profits and do not care about the social profits. These profits are only maximized when the marginal product is equal to "0", which is only possible when there is a "more than socially optimum" level of production of goods in the market.

b). According to Coase theorem, deadweight losses could be reduced by the introduction of well-defined property rights. If the property rights are well defined, then none of the agents will overproduce, because if they do overproduce, they will have to face consequences which will hamper their level of profitability.