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Coase Theorem

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A firm can produce steel with or without a filter on its smokestack. If it produces without a filter, the external costs on the community are $500,000 per year. If it produces with a filter, there are no external costs on the community, and the firm will incur an annual fixed cost of $300,000 for the filter.
a) Use the Coase Theorem to explain how costless bargaining will lead to a socially efficient outcome, regardless of whether the property rights are owned by the community or the producer.
b) How would your answer to part (a) change if the extra yearly fixed cost of the filter were $600, 000?

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Solution Summary

Coase Theorem for steel produced is determined with smokestack.

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a) Because enternality costs 500k and installing a filter only costs 300k, you can see that:

case 1, property rights are owned by community

then, the community would choose to suffer 300k (paying for filter) rather than suffering for 500k, so filter will be ...

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