The Coase Theorem and Endowment Effects
By Arnold Kling
There is a problem with the assignment of property rights on Karl Marx Street.
The street is in Griebnetzsee, a suburb of Berlin, and it sits on a hill overlooking a beautiful lake. It is very chic, with fancy villas. Truman, Churchill, and Stalin all were lodged in various houses along this street during the conference held in nearby Potsdam.
Down near the bottom of the hill, where part of the Berlin Wall used to stand, there is a path that would be very nice for pedestrians and bicyclists. If they could use it, bikers could ride all the way to Potsdam. However, some of the residents claim that the path is on their property, and they have set up bushes or other strong barriers. This forces walkers and bikers to instead ride down Karl Marx Street about one mile, until it ends, before they can join the path with no further obstructions.
The efficient solution is for bikers to be able to use the path. The Coase theorem says that we could arrive at the efficient solution with a clear assignment of property rights, and that it does not matter to whom those rights are given.
Suppose that every bicyclist carried a transponder that could be used for toll collection. If the rich residents have the property rights, then they can collect tolls from every biker who uses the path. Conversely, if the bikers have the property rights, then they would receive a “negative toll” every time they ride down Karl Marx Street because the bike path is blocked. The residents who set up the barriers on the path would be charged for these tolls. With the threat of these “negative tolls,” the residents probably would give in and unblock the paths.
My point about endowment effects is this. If you give the property rights to the rich residents, some of them might say, “I don’t care about collecting tolls. I have enough money. I don’t want bikers going through my property.” We might not see the efficient solution. On the other hand, if the bikers have the property rights, then my guess is that the threat of negative tolls would produce the efficient solution.