WELFARE EFFECTS OF COASEAN TRANSACTIONS: A GENERALIZED GRAPHICAL APPROACH

This article is about the graphical description and analysis of the welfare ef-fects of the Coasean1 transactions between the polluters and the pollutees.2 Pro-fessor Coase, in an article entitled The Problem of Social Cost (1960)3 asserted that in the absence of transaction costs, the opposed parties involved in an activity having “harmful effects” on each other may reach within the market an agree-ment that can lead to an efficient allocation regardless of the initial endowment of the property rights. According to this agreement, when the polluter has the prop-erty right (the right to pollute) the pollutee will offer him/her an indemnity to cease or decrease the activity causing the pollution. On the contrary, when the pollutee has the property right (the right not to be polluted) this time the polluter will offer him/her an indemnity to buy the right to pollute. Ronald Coase put the problem as the following: “This paper is concerned with those actions of business firms which have harmful effects on others…The economic analysis of such a sit-uation has usually proceeded in terms of divergence between the private and so-cial product of the factory in which economists have largely followed the treat-ment of Pigou in The Economics of Welfare.”4 As we know, Professor Pigou in his book “Economics of Welfare” proposed that the government can correct the dis-torted market allocation caused by externalities by imposing an appropriate tax on the polluter. This is what today is called the Pigouvian5 tax. The Pigouvian tax is imposed on the polluter as the price of polluting with a view to decrease it (ac-tually this approach is taught even today in modern books of public finance.) But Coase asserts that approaching the problem via Pigouvian taxes is of reciprocal nature: because, Pigouvian taxes designed to eliminate the harm on the pollutee inflict harm on the polluter. As a matter of fact a Pigouvian tax decreases produc-tion and consequently part of the producer’s surplus (and also the consumer sur-plus of the concerning consumers.) According to Coase instead of Pigouvian taxes the conflicting parties may reach an agreement within the market framework in which the party who does not have the property right may offer an indemnity to the other party having it. George Stigler called Coase’s argument as “theorem”6. After Coase a large number of scholars went over the matter. An immense literature was developed on the subject. Some of the articles were against and some for the Coase’s assertion. Here in this article none of these are discussed and the va-lidity of the Coasean assumptions and propositions are not questioned at all. The original contributions in this article are the following: 1-The generalization of the cases or models within which the polluters and the pollutees can bargain; 2-The microeconomic equilibrium of the concerning parties after the transaction; 3- The welfare change of each side after the transaction. This article takes the Coase’s assertion as valid and uses the tools of the public sector economics and especially of cost-benefit analysis in the description of different possible transaction cases and equilibrium analyses.