Slide 1

Negative Externalities Consider the polluting factory: the cost of the smoke and pollution to residents nearby is external to the factory. Q P PmPm Private Marginal Cost Total Marginal Costs Q*Q* Q Too Much Pigouvian analysis: D=deadweight loss (inefficiency) Solution: tax factory so private costs=total costs Internalize the externality D

Slide 2

In 1960 Coase showed that the Pigouvian analysis was wrong. External costs do not necessarily create inefficiencies. Consider our polluting factory again. If firm cuts output from Q Too Much to Q * it loses C in producer surplus. Q P Q*Q* Q Too Much A Total Marginal Costs Private Marginal Cost D B C Nearby homeowners benefit by D+C, more than the loses by the factory. If transaction costs are low the two parties should be able to find an exchange to make both better off. e.g. homeowners pay factory D/2+C to reduce output to Q * Both parties gain!

Slide 3

Market will internalize some externalities automatically Opportunity cost If homeowners are willing to pay to have externality reduced then the external cost is a cost to the firm. A profit maximizing firm will take into account the costs it imposes on others as long as it is efficient to do so Q P Q*Q* Q Too Much A Private marginal costs when transaction costs are low Private Marginal Cost, traditional view D B C Private marginal costs when transaction costs are low and damages tax is imposed Q Too Little Now look at effect of damages tax An efficient outcome becomes an inefficient one!

Slide 4

The divorce rate in the United States has increased significantly over last 30 years. One way to classify divorce: unilateral vs. mutual. Under a mutual divorce rule both parties must agree to divorce. Under a unilateral divorce rule only one party needs to desire divorce for the divorce to be granted. In the 1970s there was a movement towards unilateral divorce.

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Slide 6

Using the assumptions and predictions of the Coase theorem what should be effect of either law on divorces? Consider John and Mary and Tom and Gerri, who place different values on being married: John$7Tom-$12 Mary-$5Gerri$10 Total$2Total-$2 Image from Divorce-Education.com Coase theorem says that John and Mary should stay together, and Tom and Gerri should split up. Unilateral divorce: John pays Mary to stay together; Tom and Gerri divorce with no payment. Mutual divorce: Tom pays Gerri to divorce; John and Mary stay together with no payment.

Slide 7

Law should not change the number of divorces, divorce still takes place when joint benefit of marriage < joint cost of marriage It should, however, effect how partners are compensated Mutual divorce gives property rights to the spouse that wants to stay married, they must be compensated in order for a divorce to ocurr. Unilateral divorce gives property rights to the spouse who wants to leave, they must be compensated if the marriage is to stay intact.

Slide 8

The actual effect of the change in trend from mutual to unilateral divorce on divorces in the United States has been debated in the literature. Elizabeth Peters (1986) finds that this change had no effect on the number of divorces, but did effect compensation in the form of spousal support at divorce. Leora Friedberg (1998) finds the shift to unilateral divorce had a positive and permanent effect on the divorce rate (but explains only 17 percent of the change in divorce rates between 1968 and 1988.) Justin Wolfers (2006) argues that this positive effect was only temporary, and leveled off after about a decade so that in the end it had no discernable effect. Stevenson/Wolfers (2003) show the effect of divorce law change on well-being and spousal relations.

Slide 9

Peters suggests two possible models for the marriage contract Symmetric Information Both spouses have the same information about the value of their alternatives to marriage (value of divorce) Bargaining is costless Similar to Coase theorem assumptions Asymmetric Information Neither spouse knows the value of the others alternatives Incentives to lie about opportunities to gain larger share of marital wealth Bargaining is successfully prevented

Slide 10

X=Initial marriage wage for wife A w/h =Value of opportunities outside of marriage for wife or husband Wife wants divorce when A w >X (A,C,D) M is the joint product in marriage. Husband when A h >M- X or M-A h