Rights, Free Exchange and Widespread Externalities

Sen’s libertarian paradox is ascribed to the inevitable conflict between the Pareto criterion and individuals’ rights to create negative externalities. Finite coalitions can effect exchanges of rights through Coaseian bargains in order to resolve inefficiencies due to local externalities. With a continuum of agents, however, finite coalitions are powerless to affect widespread externalities, except those that are regulated by policies such as inefficiently allocated quotas. Then finite coalitions may gain by exchanging such quotas, but Pareto improvements may require originally unused quotas to be confiscated. Thus, the voluntary exchange of rights may exacerbate widespread externalities. Journal of Economic Literature classifications: D62, D71.