smelly cat, smelly cat, it's not your fault

so an interesting study in property rights has arisen in my apartment. it involves a cat. roommate A, who's graduating, has found a subletter who owns a cat. in this case, the cat represents a negative externality which roommates B and C are trying to avoid. to avoid said negative externality would involve letting the room remain vacant (i.e. the transaction does not take place).

now clearly there are 2 methods of moving forward: 1) since A wants to avoid letting the room remain vacant (and hence incurring costs), he prefers to have the transaction go through. so that B and C won't block it, A should compensate B and C to suffer the cat. in this case, A gains the rent from subletting (we assume that A's original rent obligation is a sunk cost and does not factor into the decision), while B and C are compensated for their disutility from cat.

2) since B and C would like to avoid the cat, they should compensate A for his loss in rent from subletting. in this case, B and C would pay a certain amount to A to offset his loss, and the transaction does not take place. B and C avoid the cat, while A gains compensation from them.

what we have here is a classic example of coase theorem. there is some payment in both scenarios which leads to an optimal outcome. but as the classic coasian problem goes, the problem of course is who the property rights belong to. and in this case, it is a very thorny situation since A, B, C and myself are all co-signers of the lease. legally, A doesn't quite have the right to sublet without B and C's approval. that said, B and C are bound by friendship to A not to do something which would essentially cause him to lose a significant sum of money.

there's another way of looking at things. if B and C's disutility from cat is very high, they would pay a sum acceptable to A to avoid it. it doesn't make sense for A to compensate B and C because that would cause any gain he has from subletting to disappear. if however, B and C's disutility from cat is relatively low, then there should be an acceptable sum of compensation which they will take to accept the cat. it doesn't make sense for them to pay because they would not wish to pay enough to make A decide to abort the transaction. this implies that the "market" can have only one outcome in either scenario, without even considering who has the property rights at all. a pareto improvement can only come in one way, regardless of who has the right to decide.

that is quite an interesting outcome, and might explain why property rights fail in so many cases. there is simply an inability to compensate for a lot of externalities. it is one of those irritating outcomes of economics: the more you value something, the more you can be made to pay for it, and hence the more you are likely to be taken advantage of. this brings in issues of revealed preferences and game theory, since the negotiation of compensation would require significant consideration of utility and some amount of guesswork.

i'm not sure whether that analysis was sound, but i had a lot of fun thinking about it. as for myself, i actually like cats. maybe i should offer to compensate B and C so i can gain the positive externality of said cat. but then again, i don't think i like cats that much.