| Consumption of goods often imposes externalities on non-consumers. The celebrated Coase theorem analyzes the problem of externalities and states that, given well-defined property rights, risk-neutral agents with transferable utilities, and the absence of transaction costs and wealth effects, the parties involved in a dispute will bargain to the same efficient outcome regardless of the initial assignment of property rights. However, it only considers anonymous (or often termed identity-independent in literature) economies. My thesis addresses the issue of market anonymity and extends the analysis of externalities into a more general, identity-dependent economy. I find that the ultimate allocation through bargaining will, contrary to Coase's conclusion, depend on the initial ownership. The inapplicability of the Coase theorem results from a unique phenomenon called cyclic trading where some players trade among themselves without ever consuming the object. When consumption and cyclic trading co-exist in a bargaining equilibrium, the initial ownership becomes relevant to the bargain outcome.; The significance of trading cycles in bargaining equilibria goes beyond the Coase theorem. I explore the implication of cyclic trading in the following directions. (1) Inefficiency. The outcome in a bargaining equilibrium with cyclic trading is always inefficient. (2) Pricing bubbles. The cyclic trading price could be higher than the market fundamentals, which means that a persistent asset-pricing bubble will appear in a trading cycle. (3) Inefficiently low consumption. While conventional analysis implies that there is likely to be excessive consumption in the presence of negative externalities, my thesis shows that negative externalities may lead to inefficiently low consumption. (4) Bilaterality. A necessary condition for there to be a non-diminishing amount of side payment is the presence of trading cycle. In other words, any equilibrium transaction that leads to consumption is "approximately bilateral". Even if the side payments in a trading cycle might not converge to zero, adopting multilateral bargaining mechanism does not affect existence of trading cycle and its properties such as inefficiency or bubbles. |
