Question

Suppose a sheep rancher leases the mineral rights beneath her grazing land to an oil company. Because she fears that discharges from the oil wells will pollute her underground water resources. The contract for the sale of mineral rights requires that the rancher and the oil company reach a mutually agreeable solution to problems of water contamination, should they arise. If such bargaining fails to result in an outcome acceptable to both sides, the mineral rights lease will be terminated automatically, and the rancher will be required to return a portion of the lease proceeds to the oil company. The portion that must be returned to the oil company is to be determined through a process of binding arbitration.

According to the Coase theorem, which of the following is the more likely outcome? Assume that profits generated by the oil company from the lease exceed the rancher’s loss from the water contamination.

a) The two parties successfully negotiate a conclusion acceptable to both sides.

b) The mineral rights lease is terminated, and the rancher returns a portion of the lease proceeds.

Answer 1

According to the Coase theorem, the more likely outcome is that the sheep rancher and the oil company will successfully negotiate a mutually agreeable solution to water contamination issues, as this will lead to an economically efficient resolution. Therefore, option a, the two parties successfully negotiating a conclusion acceptable to both sides, is the more likely outcome under the assumptions of the Coase theorem.

Step-by-step explanation:

The question refers to the application of the Coase theorem in the context of property rights and resolving externalities between a sheep rancher and an oil company. According to the Coase theorem, if property rights are well-defined and transaction costs are negligible, parties will negotiate to reach an agreement that maximizes economic efficiency, irrespective of the initial allocation of rights.

Considering the scenario where the profits generated by the oil company exceed the rancher's loss from water contamination, it is more likely that the two parties will successfully negotiate a conclusion acceptable to both sides.

This outcome is preferred as it allows the maximization of total wealth, and according to the Coase theorem, the exact allocation of property rights is less important than the ability of parties to negotiate.

Therefore, option a, the two parties successfully negotiating a conclusion acceptable to both sides, is the more likely outcome under the assumptions of the Coase theorem.

According to the Coase theorem, the more likely outcome in this situation would be option a) The two parties successfully negotiate a conclusion acceptable to both sides.