COASIAN RESOLUTIONS OF 2-PARTY EXTERNALITIES - A SPECIAL CASE OF BILATERAL MONOPOLY

The Cease Theorem (CT) states that under certain conditions, private n egotiations by the affected parties produces the welfare-maximizing re sponse to externalities (like pollution). The abatement level is suppo sed to be the same whether liability rules require payments by the suf ferer to the polluter or vice versa. There is widespread agreement and supportive experimental evidence that the CT is valid when its many s tringent assumptions are satisfied. Therefore, most previous criticism of the CT's policymaking relevance has been based on the fact that it s assumptions - especially zero transaction costs and no income effect s - are usually not realistic. This article uses a theoretical-diagram atic analysis to fill in a small, but significant, gap in the Cease Li terature. The conclusion is that liability rules will affect negotiate d abatement levels even when transaction costs and income effects are negligible. That finding is based on the incompatibility of the zero t ransaction costs and competitive behavior assumptions, and that liabil ity rules determine not just who the seller is, but also what is sold. Negotiations are likely to lead to higher abatement levels when pollu ters must buy permits to pollute from sufferers, and lead to lower aba tement levels when sufferers must buy abatement from polluters.