Regulation of Externalities Through Property Rights

The economist Ronald Coase, whom we mentioned earlier in the context of the optimal boundaries of the firm and transaction costs, postulated that the problem of externalities is really a problem of unclear or inadequate property rights.1 If the imposition of negative externalities were considered to be a right owned by a firm, the firm would have the option to resell those rights to another firm that was willing to pay more than the original owner of the right would appreciate by keeping and exercising the privilege.

For those externalities that society is willing to tolerate at some level because the externality effects either are acceptable if limited (e.g., the extraction of water from rivers) ...

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