Coase Theorem

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Coase Theorem

• The initial allocation of legal rights and
  liabilities will not get in the way of the
  efficient allocation of resources
• Where parties to a transaction are fully informed
  about the consequences of alternatives
• Where parties to a transaction can bargain freely
  and costlessly AND
• Where parties to a transaction can monitor and
  enforce compliance with contracts costlessly

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That Means

• It doesnt matter who owns what, the person who
  can use IT best (measured in terms of willingness
  and ability to pay) will end up with IT
• It doesnt matter who is responsible for the
  design, manufacture, or sale of a product, its
  attributes will be efficient

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It Doesnt Mean

• That the distribution of income or wealth will be
  the same regardless of the prior distribution of
  rights and liabilities
• (The distribution of income or wealth after a
  transaction depends on the distribution of wealth
  (assets or rights minus liabilities or
  obligations) prior to the transaction)

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Solution
Annualized Cost of Spark arrester 3000
Annualized Cost of Fire Damage 4500
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Annualized Cost of Spark arrester 3000
Annualized Cost of Fire Damage 1500
Does it Matter who is Liable for damages? NO
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What Happens if Railroad is Liable?

• If fire damage 4500, Railroad Co. buys spark
  arrester

• If fire damage 1500, Railroad Co. pays
  damages to farmers

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What Happens if Farmer is Liable?

• If fire damage 4500, farmer buys spark
  arrester for Railroad Co.

• If fire damage 1500, farmer stands ready to
  put out fires caused by train

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Moral Hazard(term comes from insurance industry)

• The WASTEFUL behavior induced when people do not
  bear the full consequences of their actions
• IN THE TRAIN/FARMER EXAMPLE, WHICH ASSIGNMENT OF
  LIABILITY WAS MORE LIKELY TO CREATE A MORAL
  HAZARD?
• Farmer or Railroad Co.?

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Asymmetric Information Costs

• Search cost -- the cost of obtaining full
  knowledge of the THING being transacted including
  the consequences of its use and its alternatives
• Bargaining cost -- the cost of reaching a
  mutually satisfactory contract
• Monitoring and enforcement costs -- the cost of
  insuring compliance with contractual terms

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In the information asymmetries, market incentives
together with either public provision of
information or in the case of information
asymmetries reassignment of liability, public
certification, or enforced disclosure will often
produce more efficient outcomes than will a
regulatory program that restricts the range of
goods and services made available, enforces
maintenance standards, or establishes maximum
levels of exposure to health and safety hazards.
Where participants in private market
transactions err only because information is
absent, public provision of information will be
more efficient than regulation. This follows
from the observation that public provision of
information can meet economic objectives without
removing alternatives from the market that some
consumers or workers would prefer.
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Kinds of Product Liability(all theories of
product liability require the injury to be
related to product use -- reflect changing
reality about who is best located to make
knowlegeable choices about net benefits)

• Caveat Emptor
• Negligence
• Strict Liability
• Voluntary and knowing assumption of the risk
  (known and avoidable danger)
• Contributory negligence (not just misuse)
• Disclaimers
• Absolute Liability

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Damages(no right without a remedy)

• Economic Losses (replacement cost, out of pocket
  expenses)
• Compensation for Pain and Suffering
• Punitive Damages

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Regulatory Optimum