An Incompatible Activities Mechanism

This paper designs a mechanism that generalizes Ronald Coase's farmer-rancher example of nuisance law from his seminal article, “The Problem of Social Costs.” The mechanism incentivizes truthful reporting of the agents' private net benefits and costs of bilateral activity levels, thereby addressing Coase's concern that judges might not know how to determine the optimal activity levels. The model determines a property rights regime endogenously as a dominant strategy equilibrium that enables strategic agents with asymmetric information to arrive at efficient outcomes. Mechanism design encompasses the Pigouvian-social-planner and Coasean-transaction-cost paradigms as special cases, while accommodating alternative societal objectives, various equilibrium concepts, endogenous transaction costs, strategic agents, private information, truthful revelation of private costs and benefits, incentive compatibility, voluntary participation, and budgetary feasibility. These features extend previous paradigms and test their robustness in more sophisticated economic environments. The mechanism design paradigm provides modern theoretical foundations for economic analysis of law