PRODUCTION EXTERNALITIES AND LONG‐RUN EQUILIBRIA: BARGAINING AND PIGOVIAN TAXATION

This paper analyzes bargaining and Pigovian taxation solutions to inefficiencies from production externalities with free entry. The Coase Theorem fails in a decentralized context but remains valid if the property rights holder can act like a command economy planner. A less powerful price‐taking rights holder's objective function is nonconcave, causing an inefficient bargaining outcome. Bargaining complicates Pigovian taxes with a nonlinear tax scheme required to sustain the optimum. Polluting firms pay a franchise tax whose revenue is given lump sum to consumers and face a marginal charge only on excess output, which thus raises no revenue in equilibrium.