Question

Mary and Cathy are roommates. Mary assigns a $30 value to smoking cigarettes. Cathy values smoke-free air at $15. Which of the following scenarios is a successful example of the Coase theorem? a. Cathy offers Mary $20 not to smoke. Mary accepts and does not smoke. b. Mary pays Cathy $16 so that Mary can smoke. c. Mary pays Cathy $14 so that Mary can smoke. d. Cathy offers Mary $15 not to smoke. Mary accepts and does not smoke.

Answer 1

b. Mary pays Cathy $16 so that Mary can smoke.

Explanation:

Coase's theorem suggests that in a situation where a bargaining situation, where there is efficient pareto allocation, economic agents can negotiate and come to a compensation agreement on the loss of welfare.

Pareto Optimal is a state where resources are allocated as efficiently as possible. Any reallocation of resources to improve one individual's situation will necessarily worsen another individual's condition. That is the case in point. Mary has a $ 30 utility for smoking, while Cathy has a $ 15 utility for fresh air. If both are in the same environment, Mary's activity will damage Chaty's usefulness. A deal would be if Mary offered Cathy a reward beyond her usefulness, and was then allowed to smoke. Since Cathy's utility is $ 15, if Mary offers $ 16, Cathy's utility will be greater with Mary smoking than before.