6. Problems and Applications Q6 Clancy loves playing rock 'n' roll music at high volume. Hubert loves opera and hates rock 'n' roll. Unfortunately, they are next-door neighbors in an apartment building with paper-thin walls. In this case, imposes a externality on his neighbor in the form of noise pollution. Why might a command-and-control policy that forbids music to be played above a certain decibel level lead to an inefficient outcome? An efficient outcome can be achieved only if everyone can do what they love. It is unfair because such policy would restrict Clancy's activity but not Hubert's. Clancy playing his music loudly does not do any harm if Hubert is not home. Suppose the landlord lets the tenants do whatever they want. True or False: According to the Coase theorem, Clancy and Hubert can never reach an agreement without a third party assisting in the negotiations. True False

A Negative Externality refers to the negative effects on a third party that was not party to the transaction that is causing the negative effect. Here Clancy is listening to Rock 'n' Roll music loudly which is the transaction. Hubert feels affected by this even though Hubert has nothing to do with Clancy playing the loud music.

2. Clancy playing his music loudly does not do any harm if Hubert is not home.

Such a command-and-control policy would be inefficient because it would not take into account the times when Hubert is not harmed by music and just place uniform restrictions of Clancy. A policy needs to be employed that caters for the times when Hubert won't be affected thereby giving Clancy freedom to play the music as Clancy wants.

3. False

According to the Coase Theorem, parties facing an externality dilemma can actually work out their problems by themselves provided that the cost of doing so is not a lot. Clancy and Hubert can therefore reach a solution on their own without outside help if the cost of doing so is not too high.

In reality however, it is quite hard for both parties to reach a consensus on their own and so a third party is usually needed to mediate.