Crazytown is a densely populated city, with an airport next to it. Without government intervention, the airplanes landing at, and departing from, the airport would cause a lot of noise disturbance for the inhabitants of Crazytown. Suppose that the cost of limiting the airplanes’ noise is lower than the total cost imposed by the noise on the inhabitants. Explain why Coase’s theorem fails in this case, and why it is best for the government to impose regulations on the noise that airplanes make.


In this case, if the property rights to a silent airspace would be assigned to the airport, the inhabitants of Crazytown would need to organize themselves or negotiate individually about a compensation for the airport to limit its noise. Such negotiations incur high transaction costs, and Coase’s theorem does not apply. It is better to assign the property rights to the inhabitants of Crazytown. In this case, regulation imposes that the noise made by the airplanes is limited, and the efficient situation is attained.


My question is about the last part of the solution:

Q1: Why is it better to assign the property rights to the inhabitants of Crazytown? In this scenario, the airport still needs to negotiate with the inhabitants of Crazytown to reach a pareto efficient outcome, which results in large transaction costs.

Q2: From a more general point of view. If the conditions of the coase theorem (trade in externalities is possible and low transaction costs) are not met. How is it determined which party party should be granted the property rights to reach an efficient solution?

If I could get feedback on this, that would be helpful!


1 Answer 1


A1: Because the transaction costs for individual villagers would be higher. It is much easier for large airport to higher a negotiation team to go from home to home and negotiate than for villagers to do the same thing. In fact the airport will probably already have some law and public relations department. So while in real life you are correct there will be some transaction costs, they will be smaller for the airport.

A2: If the Coase theorem conditions are not met then it might not be possible to reach best solution by negotiations. You might settle down for second/third best solution and still assign the property rights to party with lowest transaction costs or use some alternative mechanism like government regulation of noise level and then who has property rights becomes inconsequential for this particular issue (noise pollution).


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