Production Externalities and Long-run Equilibria: Bargaining and Pigovian Taxation

Jonathan Hamilton, Eytan Sheshinski and Steven M Slutsky

Economic Inquiry, 1989, vol. 27, issue 3, 453-71

Abstract: This paper analyzes bargaining and Pigovian taxation solutions to inefficiencies from production externalities with free entry. The Coase Theorem fails in a decentralized context, but remains valid if the property rights holder can act like a command economy planner. A less-powerful, price-taking rights holder's objective function is nonconcave, causing an inefficient bargaining outcome. Bargaining complicates Pigovian taxes with a nonlinear tax scheme required to sustain the optimum. Polluting firms pay a franchise tax whose revenue is given lump sum to consumers and face a marginal charge only on excess output, which, thus, raises no revenue in equilibrium. Copyright 1989 by Oxford University Press.

Date: 1989
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