Ethics in Environmental Economics: Coase Theorem

Environmental economics objectively looks at natural resources and environmental issues from a market perspective. In the traditional model, supply (private marginal costs) is equal to demand (social marginal benefits) that create a socially optimal equilibrium. When private marginal costs differ from social marginal benefits, an externality is produced. Transitioning from what an externality looks like graphically, “An externality exists when a person makes a choice that affects other people in a way that is not accounted for in the market price.” [1] These choices are generally based off production and consumption needs by an individual or firm and can be positive or negative. Since individual choices are not accounted for in the market price, the nonexistent natural correction for the market failure creates a loss of Pareto efficiency. However, in 1960, economist Ronald Coase recommended a private solution of to how an individual ought to deal with an externality. The Coase Theorem was praised for its comparatively unconventional approach and led some to believe that it was fundamentally different. This paper will analyze the economic logic and identify implicit moral presuppositions involved in the Coase Theorem that achieve the same socially optimal outcome of other neo-classical environmental economics models.

The Coase Theorem states that in the presence of an externality, if there are sufficiently low transaction costs, bargaining will lead to a Pareto efficient outcome regardless of which group receives the initial property rights. For a better understanding of how this theorem would be applied in the real world, below is a common example:


Factory dumps pollutants into a clean lake:

-Fishers suffer losses = $1000

-Fishing losses can be restored if the factory buys $500 of pollution control equipment

Two ways to assign property right to lake:

Fishers Wins: Right to be free of pollution

-Bargaining results in factory buying equipment; Costs $500 and Benefit $1000

-Leads economically efficient

Firm Wins: Right to pollute

-Bargaining results in fishers to buy control equipment

-Costs $500 and Benefits $1000

-Leads to economics efficiency



Again, Coase was attempting to find a private solution to the presence of an externality in a seemingly separate way from traditional solutions like cost-benefit analysis, or Pigouvian taxes or subsides. Here it should be noted that the core notion of what is optimal or efficient in the Coase Theorem, is parallel to theorems in welfare economics which is fundamentally based on individual preference satisfaction. I will point out seven features that represent the economic logic or assumption needed in order to achieve a socially optimal outcome. Each feature displays what Robert Coase thought economic agents ought to do when conflicted with an economic affair such as an externality.


  1. Coase is evaluating an economic affair (negative externality) and provides a solution of how each party can makes themselves better off. Notice that his focus is primarily on the outcome through property rights.


  1. Coase Theorem is a short run notion that only has one concept of what is “good” or what someone ought to do to obtain an “efficient” outcome.


  1. The Coase Theorem disregards equity and understanding of the environmental impact the externality causes. In our example, the theorem completely disregards the significant environmental impacts of dumping pollution in the lake. The initial pollution cost the fishers $1000 worth of benefits. What happens in the long run or if they don’t gain property rights?


  1. What made the Coase Theorem so appealing and different compared to CBA or Pigouvian taxes is that no government intervention is necessary. Instead Coase built his theorem on the notion that each agent, given the externality, would be desperate enough to bargain some kind of socially optimal outcome. In our example, the fisherman might be so desperate for the factory to stop polluting that bargaining for control equipment is more important than gaining initial property rights.


  1. Regardless of who is assigned initial property rights, the bargaining between the economic agents should have stabilized the relationship in order for the efficient outcome to still achieved. However, this notion of efficiency is a Pareto improvement. The reallocation of a good (or the lake) is improving either parties. The party who receives the initial property rights (winners) can compensate the other party who does not receive the initial rights (loser). “As Coase (1960) proved under some fairly restrictive assumptions, the same “optimal” amount of pollution will result with either assignment rights.”[2]


  1. Transaction costs must be little to none. However, it’s evident in the example above if an individual is incurring damages (like the fisherman), need to be able to afford to bride someone not to incur damages (the firm).


  1. The key to a successful outcome can only arise if these assumptions are met. Otherwise serious limitations will prevent any kind of socially optimal outcome to be reached.


The Coase Theorem is one of the many different tools firms and other individuals can use to exploit and justify their individual preference satisfaction. Like the example above, “Those who pollute the air or deplete the fish population in a lake often need not take the costs imposed on others into account in their private calculations of economic costs and benefits.”[3] They don’t need to take costs and benefits into account because 1) the externality doesn’t affect them, 2) environmental economic policies are formulated around correcting market failures based on individual satisfaction.  “None of these tools are designed to serve “nature’s” interest, or the “national” interest, or “what god wants,” or even “human health” (as a substantive outcome independent of the level of health that people prefer).”[4] If a firm or individual wants an optimal outcome that addresses both economic and environmental issues, environmental economic policy is no the right tool. However, there are other heterodox approaches to forming policies – ecological economics ect. – that include issues like environmental damages into the models.

Environmental economics however, is first and foremost neo-classical economic approach to solving environmental issues. The Coase Theorem is just one of many market-friendly tools that help individuals correct the market failure the externality ends up creating. Although the Coase theorem mainly just works as a private solution for externalities, and other policies work better in other areas, each fundamentally achieving the same goal of individual preference satisfaction.


[1] “Coase Theorem.” Wikipedia. Wikimedia Foundation, 29 Mar. 2017. Web. 09 Apr. 2017.

[2] Hausman, Daniel M., and Michael S. McPherson. “”Efficiency” as Pareto Optimality.” Economic Analysis, Moral Philosophy, and Public Policy. New York: Cambridge UP, 2006. N. pag. Print.

[3] Hausman, Daniel M., and Michael S. McPherson.

[4] Wade Hands

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