If the residents have the property right

Now suppose that each party continues to face (possibly different) specific per unit transaction costs, but suppose that the residents have the right to choose the level of Q. In the absence of any bargaining with the factory, the residents would choose Q = 0. Now suppose that the factory and the residents bargain over the level of production of Q. Again, let the factory face a transaction cost of t'F per unit of production of Q that is negotiated in excess of the initial allocation Q = 0, where in general t'F Ф tF. Similarly, let the residents face a transaction cost of tR Ф tR per unit of production of Q that is negotiated in excess of the initial allocation.

In this case, the roles of the parties are reversed. The payment by the factory per unit of increase in the level of Q now consists of the money price P', plus the transaction costs tR it incurs in bargaining with the residents. Thus the full price paid by the factory is: Per unit transaction costs when the residents enjoy the property right

Figure 3.5.2 Per unit transaction costs when the residents enjoy the property right

On the other hand, the benefit received by the residents per unit of increase in the level of Q again consists of the new money price P which it receives from the factory, less the transaction costs tR it incurs in bargaining with the factory. Thus the price received by the residents is:

The common money price P' is again determined by the commonality of marginal rates of substitution inclusive of transaction costs:

Note that the gains from trade are again completely exhausted, but in the presence of transaction costs, the gains from trade are now exhausted at the point Q = Qn < Q*. The total transaction costs incurred are

The aggregate gains from trade to each party are again lower than they were in the absence of transaction costs, although the gains to each party individually may be higher or lower than they were in the absence of transaction costs.

 
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