Controlling Externalities and Protecting Entitlements: Property Right, Liability Rule, and Tax-Subsidy Approaches

A VARIETY of approaches have been suggested for the control of externalities.' Advocates of the property right approach first determine what each party in the externality conflict is "entitled" to. The entitlement is then protected by giving the holder of the entitlement the right to enjoin the other party from adversely affecting the holder. Proponents of the liability rule approach also begin with the determination of entitlements. However, the entitlements are then protected by a rule which allows the "active" party to initially reduce the value of the "passive" party's entitlement but thereafter be liable to that party for "damages" determined by some collective body.2