Coase Theorem

The assertion that whenever there are externalities, the parties involved can get together and make some set of arrangements by which the externality is internalized and efficiency is ensured, is referred to as the Coase theorem. (Stiglitz, J (2000) Economics of the Public Sector (3^rd edition))

In other words, even though there are externalities between individuals, the government’s intervention for market is not needed under the condition that there are less transaction costs and clear property rights for individuals. So, to internalize externalities, there is a solution about using a single buyer to give clear property rights in public economy.

(from Professor Scott's class material)

 The example of single buyer is a farmer monopolizing a ranch for his cow. For example, there are 6 farmers on a ranch and each farmer has a cow. To increase milk production, each farmer buys more cows. The grass on the ranch will be decreased by grazing of a lot of cows. If the reduction of the grass causes the decrease in milk production, each farmer will buy more cows for their own interests. In this sense, the quality and quantity of the grass on the ranch cannot be managed well by famers, because they have fewer concerns about it. On the other hand, if only one farmer use the ranch, he will be concerned a lot about the ranch and not overuse the grass to improve his cow’s milk production. In other words, the farmer is given property right for a ranch. This solution is related to the R. Coase’s assertion. As I mentioned, even though I produce negative externalities, I do not need to pay anything for them. However, if I have a property right which is the right to control some assets and to receive fees for the property’s use, I will pay a lot of attention to creating negative externalities to reduce harm on my property. Even when I share property rights with others, the market may find an efficient way of dealing with the externality.