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Published by Erik F. Meinhardt
This paper aims to describe in detail the problem of externalities, moves to discuss Coase’s theorem, and concludes by disproving it.
This paper aims to describe in detail the problem of externalities, moves to discuss Coase’s theorem, and concludes by disproving it.

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Published by: Erik F. Meinhardt on Jun 03, 2007
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Erik F. Meinhardt 
 This section aims to describe in detail the problem of externalities, moves todiscuss Coase’s theorem, and concludes by disproving it.
I.What are externalities?
—Externalities are third party effects arising fromproduction and consumption of goods and services wherein the thirdparty receives no appropriate compensation. Externalities causemarket failure if the price mechanism does not take account of thesocial costs and benefits of production and consumption. They cause aloss in social welfare because the market mechanism provides thewrong amount of goods and services to consumers. Externalities occuroutside the market because they affect third parties—that is agentswithout direct involvement in the production and consumption of aparticular good or service.For markets to work efficiently, society must assign property rightsclearly. If no one owns a particular good, then no one has an economicincentive to protect that good from abuse. This leads to the “Tragedy of the Commons,” where, for example, no one owns the ocean or the fishin the ocean so the fishing industry decimates the population of livingfish, causing a shortage.Because of the absence of clearly defined property rights the marketfails to account them when assigning prices of goods and services. In asituation lacking government intervention, because no one owns theair, for example, polluting industries do not increase their prices to payfor correcting their pollution. The fact that they do not correct airpollution, though, leads to health problems among third parties and thethird parties must then pay for the correction of their health.
—The following five specific examples of externalities, manyof which have an environmental theme, demonstrate their harms.
Many states have made it illegal to smoke in theworkplace and public places in general. Second-hand smoke inthese places has been described as a pollutant which places highhealth risks onto those breathing in second-hand smoke. Itincreases the risk of breast cancer in women, premature births, andasthma in children. Even though some people do not smoke, thecosts of smoking are externalized onto them anyway.
—The World Health Organization says 3 million people arekilled worldwide by outdoor air pollution annually from vehicles andindustrial emissions, and 1.6 million indoors through using solid
fuels. Some estimates have 7-20% of all cancers resulting from airpollution alone. Diseases carried in water are responsible for 80% of illnesses and deaths in developing countries, killing a child everyeight seconds. Each year 2.1 million people die from diseasesassociated with poor water. Contaminated land is a problem inindustrialized countries, where former factories and power stationscan leave waste like heavy metals in the soil. Agriculture can polluteland with pesticides, nitrate-rich fertilizers and feces from livestock.And when the contamination reaches rivers it damages life there aswell.
Drugs and alcohol
—A York University study says heroin and crackcocaine addiction costs the UK £19 billion a year, with each addictcosting £600 per week in crime costs and court time, health careand unemployment benefits. Also, excessive drinking is on the risein the United States and the UK, costing millions of dollars in healthcare costs and tens of thousands of drinking-related deaths eachyear.
—The UK estimates its cities pay about £150,000 a year ongum removal. On London's shopping main shopping road, OxfordStreet, for example, there are more than 300,000 pieces of chewinggum. The City Council spends more than £100,000 a year dealingwith the problem. Some people are calling for a gum tax to offsetthe cost of this externality while others want the manufacturers topay the cost of making biodegradable forms of gum.
The movement of food 
—A UK government report found that theenvironmental cost of moving food was as much as £9bn a year. This is a result of increased truck traffic delivering the food, traveltime of the consumer to get the food, overall traffic congestion,traffic accidents, and pollution as a result of the shipments.
II.Coase’s theorem
Coase’s theorem states that given well-defined property rights, lowbargaining costs, perfect competition, perfect information and the absence of wealth and income effects, resources will be used efficiently and identicallyregardless of who owns them. To understand Coase’s argument, we must look at an example, first. Take anindividual who buys property directly next to a loud factory which has beenoperating for 25 years. This individual then builds a music recording studioon the side of his property directly next to the noisy factory. Assuming theindividual knew the factory created a lot of noise, are they able to file for aninjunction against the factory for making too much noise? Coase’s first step,as I have shown with this example, is to establish that externalities (such as

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