Chapter Outline

Externalities provide a benefit to one party, while they harm another.
When parties affected by externalities can negotiate costlessly with one another, an efficient outcome results, no matter how the law assigns liability for damages (Coase theorem).
1. If the confectioner in the text is liable, but cannot stop the noise of his operation as easily as the doctor can insulate against it, the confectioner will pay the doctor to insulate.
2. If the doctor does not have rights to silence, then he will insulate on his own.
When negotiating costs are positive, the most efficient laws place the burden of adjustment to the externalities on those who can accomplish it at least cost.
1. Planes flying overhead or swimmers walking on beach property are examples of activities that continue because of efficient laws.
2. Zoning laws on building additions and regulations on the size and position of signs and billboards illustrate how laws seek to be efficient.
3. Shifts in the structure of property rights, as in the textbook example of fences between farms and ranches in the Canadian West, illustrate how laws evolve to reflect efficient solutions to externalities.
When property rights are not defined, individuals use the resource until their average return equals their marginal cost.
1. Grazing on common pastures or fishing in common ponds show how this lack of property right definition leads to overuse of a resource.
2. Unrestrained speech or smoking in public are further examples of instances where rights are hard to determine and negotiation is difficult.
The Coase theorem also applies to positive externalities since people will pay for external benefits if necessary.
Positional externalities, like those involved in arms races, athletic competitions, overtime work, consumption level competition, or workplace safety, may require laws to bring about desired outcomes.
Efficient tax policy can help in the proper allocation of resources where externalities exist.
1. An efficient pollution tax will result in those with low-cost cleanup methods doing most of the cleanup.
2. A tax on positional externalities like luxury purchases may be preferred by everyone since there may not be losers and public revenues would be enhanced.

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