Editing Coase theorem (section)

==Examples==
===Damage from water runoff===
Two property owners own land on a mountainside. Property Owner A's land is upstream from Owner B and there is significant, damaging runoff from Owner A's land to Owner B's land. Four scenarios are considered:
# If a cause of action exists (i.e. B could sue A for damages and win) and the property damage equals $100 while the cost of building a wall to stop the runoff equals $50, the wall will probably exist. Owner A will spend $50 and build the wall in order to prevent a court case where B could claim $100 in damages.
# If a cause of action exists and the damage equals $50 while the cost of a wall is $100, the wall will not exist. Owner B may sue, win the case and the court will order Owner A to pay B $50. This is cheaper than actually building the wall. Courts [[Specific performance|rarely order persons to do or not do actions]]: they prefer monetary awards.
# If a cause of action does not exist, and the damage equals $100 while the cost of the wall equals $50, the wall will exist. Even though B cannot win the lawsuit, he or she will pay A $50 to build the wall because the wall is less costly than the damages from the runoff.
# If a cause of action does not exist, and the damage equals $50 while the wall will cost $100, the wall will not exist. B cannot win the lawsuit and the economic realities of trying to get the wall built are prohibitive.

The Coase theorem considers all four of these outcomes logical because the economic incentives will be stronger than legal incentives. Pure or traditional legal analysis will expect that the wall will exist in both scenarios where B has a cause of action and that the wall will never exist if B has no cause of action.

# a Court of Law orders owner A to limit its operations.
# a Court of Law orders owner A to compensate Owner B.
# a Court of Law pays Owner A the gains it makes from causing the runoff.
# a Court of Law compensates Owner B the losses it makes from bearing the runoff.
# Owner A pays Owner B the losses it makes from bearing the runoff.
# Owner B pays Owner A the gains it makes from causing the runoff.

===Planting pear trees===

The Jones family plants pear trees on their property which is adjacent to the Smith family. The Smith family gets an external benefit from the Jones family's pear trees because they pick up whatever pears fall to the ground on their side of the property line. This is an externality because the Smith family does not pay the Jones family for utility received from gathering the fallen pears and, therefore, does not participate in the market transaction of pear production.  It results in the pears being underproduced, which means too few pear trees are planted.

Let's assume the following:

[[Image:Jonespeartree mbsch.JPG]]

Possible solutions to internalize the externality:

By applying the Coase Theorem two possible solutions arise for internalizing this externality. These solutions can occur because the positive external benefits are clearly identified and we assume that 1) transaction costs are low; 2) property rights are clearly defined.

After realizing that the Smith family gets utility from the Jones family's pear trees, the Jones family thinks it is unfair that the Smiths get utility from picking up the pears that fall from their pear trees.  The first option to eliminate the externality could be to put up a net fence that will prevent pears from falling to the ground of the Smith's side property line, which will automatically decrease the Smith family's marginal benefit to 0.

The second option for the Jones could be to impose a cost on the Smith family if they want to continue to get utility from their pear trees. Say, if the Jones family has a MC of $25 for each pear tree produced, it allows them to plant 3 pear trees a year (Jones’ MB = MC). However, if the cost is imposed on the Smiths, the optimal quantity of pear trees produced a year will increase to 4  (Jones’ MB + Smiths’ MB = MC). By internalizing the externality, both the Smith family and the Jones family increase their overall utility by increasing production from 3 pear trees a year to 4. $5 is the maximum price the Smiths are willing to pay for an additional, fourth, pear tree, which implies their marginal benefit to plant a fifth pear tree is 0.

[[Image:Jonespeartree graphs.JPG]]

===Waterworks Denmark example===
Whilst the Coase Theorem remains largely theoretical, a real life example of Coasean bargaining in the negotiations between waterworks and farmers in Denmark was published in 2012. Danish waterworks attempted to establish "voluntary cultivation agreements with Danish farmers".<ref>{{cite journal |last1=Abildtrup |first1=Jens |author2=Frank Jensen |author3=Alex Dubgaard |title=Does the Coase theorem hold in real markets? An application to the negotiations between waterworks and farmers in Denmark |journal=Journal of Environmental Management |date=January 2012 |volume=93 |issue=1 |pages=169–176 |doi=10.1016/j.jenvman.2011.09.004 |pmid=22054583 |bibcode=2012JEnvM..93..169A |url=https://www.sciencedirect.com/science/article/pii/S0301479711003331 |access-date=10 October 2020 |ref=20|url-access=subscription }}</ref> Some main takeaways from this application of the Coase Theorem were that, the farmers tried to receive over compensation by exploiting their information advantage, which in turn may have resulted in waterworks terminating negotiations. Additionally, as [[asymmetric information]] is included in transaction costs, by exploiting their information advantage, the farmers prolonged negotiations, thus demonstrating that the Coase theorem is very sensitive to its assumption of low transaction costs.