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In a recent paper in this Review, William Schulze and Ralph d'Arge employ a partial equilibrium model of two competitive industries with an externality to analyze the well-known "Coase proposition." In particular, they compare both the short-run and long-run efficiency implications of (a) the unadjusted externality case, (b) a Pigo- vian tax on the output of the firms generat- ing the external cost (the "emitting" firms), (c) a rule making the emitting firms liable to the "receptor" firms, and (d) a situation in which the emitting firms incur no liability, but firms in the two industries are free to bargain costlessly concerning the externality. The analysis in general is illuminating. However, their conclusions regarding the impact of a liability rule, both in the short run and in the long run, appear to be in error. This is of particular significance be- cause, as the authors point out, it is precisely the impact of a liability rule that has been at the center of the controversy over the Coase proposition.
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