Question

3. Imagine you have a nice garden in your back yard and one day you get new neighbors who have a pet llama. This llama sometimes gets loose from his enclosure in the neighbor’s back yard and comes over to your property and eats up some of your garden.

1. Since the llama is on your property, if you call the police, they will make your neighbor get rid of the llama. Is this what Ronald Coase would suggest you do? Explain (4 points)

Given that you clearly own the property that the garden is on, is there any way (according to Coase) in which the llama will be allowed to continue to feast in your garden? If yes, explain how that might happen. If no, explain why not.

Answer 1

A) No

Ronald Coase, in his Coase theorem suggests that in case of externalities, the market outcome can be made efficient and optimal through bargain between the two parties, given there are well defined property rights and no transaction costs.

That is, in the given case, since the llama is imposing negative cost on the garden, the efficient outcome would be for the two neighbours to bargain among each other to arrive at a mutually beneficial outcome or decision.

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Since the property is well defined in terms of property rights, a llama can be allowed to feast in the garden as long as the llama owner compensates the garden owner for an amount equal to the damage done by the llama.

This will make parties better off, making the outcome optimal.