INDUCING EFFICIENCY - EXTERNALITIES, MISSING MARKETS, AND THE COASE THEOREM

The capacity of side-payments to induce an efficient outcome, as predi cted by the ''Coase Theorem,'' is studied. Side-payments are formally introduced in a bimatrix game involving externalities, and the resulti ng equilibrium is called an induced equilibrium. When induced equilibr ia exist they weakly Pareto-dominate a Nash equilibrium of the origina l game without side-payments. When, because of externalities, one mark et is missing, an induced equilibrium always exists, is uniquely value d, and is Pareto-efficient. When more than one market is missing, indu ced equilibria may not exist, may be Pareto-inefficient, and may be Pa reto ranked.