The CFAI practice review material online had this SAVAGE question (I’d say so because it’s literally one sentence in the entire reading)
Sengupta states:
“We can use free market mechanisms to control potential pollution from the mines. Because there will be at least 4, and possibly more than 10, mining companies operating in the mining district, we can design an exchange wherein the companies can trade “pollution rights.” The government will set the total maximum amount of various pollutants that might occur from mining operations, revising that total from time to time. The companies will bid on rights that will allow them a certain level of that total pollution. If a company exceeds the level to which it has a “right”, it will be fined. By allowing the trading of these rights on an exchange, the resulting “price of pollution” will reflect the most efficient allocation of resources related to the mining district.”
Question:
Sengupta’s views regarding potential pollution from the mining district are most consistent with which of the following?
A. The Coase theorem
B. Regulatory capture
C. Regulatory arbitrage
A is correct. Sengupta’s endorsement of an exchange that trades “pollution rights” is consistent with the Coase theorem. The Coase theorem states that if an externality can be traded and there are no transaction costs, then the allocation of property rights will be efficient and the resource allocation will not depend on the initial assignment of property rights.
