The fall academic semester is quickly approaching, so it’s a good time to remind readers that one of the goals of this site is to give economics instructors interesting examples and discussion topics for their classes. Those of you teaching Principles of Economics this term (as well as those of you teaching Environmental Economics and other related topics) will probably get to a discussion of externalities somewhere toward the middle of the semester, but here’s something for those of you who are inclined to plan ahead:
The Coase Theorem is a crucial topic in a discussion on externalities, since it shows that, under certain conditions, an efficient outcome will result via bargaining regardless of how property rights are initially assigned. This is an important concept because the policy implication is something along the lines of “just do something to define property rights and the rest will sort itself out.” I usually illustrate the Coase theorem via the following scenario:
Let’s suppose that there are two people on an airplane, one seated directly behind the other. The person in front, let’s call him Josh (you’ll wee why later), values the ability to recline his seat at $20. The person in back, let’s call him Hamilton, values the space in front of him at $15. These valuations imply that the efficient outcome for the system overall is for Josh to recline, since doing so confers larger benefits on Josh ($20) than it costs Hamilton ($15).
If the airline assigns property rights to Josh, there is no room to bargain since Hamilton doesn’t value his space enough to be willing to offer Josh enough money to get him to not recline (i.e. more than $20). In this case, the result will be that Josh reclines. If the airline assigns property rights to Hamilton, a logical Josh would be willing to offer Hamilton somewhere between $15 and $20 in return for Hamilton allowing josh to recline his seat. A logical Hamilton would accept this offer, since he is getting paid more than he values his space, and the outcome would once again be that Josh gets to recline. As the Coase theorem postulates, reclining is the outcome that transpires regardless of how property rights are assigned- the difference between the two scenarios is what the payment structure looks like. (It should be acknowledged that the payment structure will of course affect how good the different parties feel about the eventual outcome, so the initial allocation pf property rights is still relevant from a distributional perspective.)
I like this example because it highlights why the assumptions underlying the Coase theorem are necessary. There are three main assumptions that are, in practice, not always satisfied:
- Property rights must be defined in some way- as stated earlier, it doesn’t matter how they are assigned, but they have to be assigned.
- Bargaining must be costless, since otherwise transaction costs could prevent bargaining or drive a wedge between the valuations of the parties that prevents adjustment to the efficient outcome.
- The decision makers in the bargaining must be economically “rational”- in this context, rationality implies thinking objectively about costs and benefits.
With all of this in mind, consider the following incident:
According to the Associated Press, a United Airlines flight from Newark to Denver was diverted to Chicago’s O’Hare International Airport after two passengers, both sitting in the “economy plus” section of the flight – which comes with extra legroom – began arguing because the man prevented the woman sitting in front of him from reclining her seat.
The man was allegedly using a $22 device, known as the Knee Defender, that locks onto the tray table on the back of the seat, making it impossible for the person in front to recline. The device is banned on United Airlines flights, but the Federal Aviation Administration leaves it up to individual airlines to set rules for the device.
According to law enforcement officials, the man used the device to stop the woman in front of him from reclining while he was using his laptop. When a flight attendant asked him to remove the device, he refused. The woman directly in front of him then allegedly stood up and threw a cup of water at him.
The flight crew determined the situation had escalated to the point that the flight needed to make an unscheduled stop at O’Hare.
I think we can all acknowledge that “grounding the plane and inconveniencing everyone on board” is not the efficient outcome, so let’s examine how the assumptions of the theorem were not satisfied:
- Assignment of property rights: To me, it seems pretty clear that the property rights belong to the recliner, for two reasons. First, there is a functional recline button on the chair- when airlines don’t allow you to recline (in front of emergency exit rows, for example), they disable the functionality as opposed to just asking you to not recline. Second, the device used to prevent the seat from reclining is banned, and it’s only a small logical jump from “preventing an activity is banned” to “said activity is allowed.” That said, this scenario highlights the fact that it’s not only the assignment of property rights that is important, but also the recognition and respect for said property rights. (When multiple parties believe that they have the property rights, you get coexisting news headlines such as “Don’t Want Me to Recline My Airline Seat? You Can Pay Me” and “Don’t Want Me to Spit on You When You Recline Your Airline Seat? Pay Me.” as opposed to effective bargaining.)
- Costless bargaining: In this type of situation in general, bargaining may not be costless for people who are averse to confrontation or if there is a fear of the other party, well, spitting rather than engaging in bargaining. Even I find bargaining to be perfectly reasonable but might think twice about trying to do so out of fear that the other party might think I’m insane. (For better or for worse, this hypothesis hasn’t even been tested because I’m short enough that this issue doesn’t play a large role in my existence.)
- Rational actors: Intuitively, it seems pretty clear that the people in the story are acting pretty crazy, but, unless we decide that throwing water is a valid and productive bargaining strategy, we can conclude that they are acting in economically irrational ways as well. Irrationally can take far more mundane forms, however- behavioral economists, for example, would point out that a person who would pay a maximum of $15 to gain their legroom would likely demand far more than $15 in order to be willing to give it up. This “endowment effect” in and of itself can prevent the objectively efficient outcome from being reached, making the initial allocation of property rights more important than it would be otherwise.
Those of you who have ever flown on Virgin America may have noticed that their seat-back menus offer the option to send a drink or other item to another passenger- I would really like to see what would happen if the company added the functionality to bargain for space via touchscreen…and, let’s be honest, Richard Branson totally seems like the guy to get on that- after all, he’s the guy who thought that this was a good use of resources:
Who am I kidding, that video is worth every penny.
Update: IT HAPPENED AGAIN. Do people not watch the news? Or take basic economics classes?