Outline the Coase Theorem; Is It Useful?

Outline the Coase Theorem; is it useful?

In the field of welfare economics social costs or negative externalities seems more important than ever. The Polar Regions are melting and the focus on pollution and what we can do to stop greenhouse effects are widely spoken of. Most of the pollution comes from companies using machinery to produce goods and from means of transport. Carbon emission from an aircraft for example, is a negative externality in its way of harming the environment. Of course the cost of environmental damage is hard to estimate, and who is actually responsible for the damage made: the aviation company or the consumers? In these cases it is fairly difficult to come to an agreement as the number of parties involved often is enormous, and therefore unlikely to be able to meet and decide on a verdict. How can this question of responsibility be solved in an efficiently way?

This essay will try to outline under which circumstances private individuals, acting on their own, can avoid externality problems through the Coase Theorem. Moreover this paper will also attempt to evaluate the usefulness of Coase’s Theorem. I will begin with an outline of the Coase Theorem and some definitions of central concepts. The next part will illustrate the Coase Theorem through an example. Then I will attempt to evaluate the usefulness of the theorem, pointing on arguments both for and against. In the latter part of the essay I will try to conclude with the most valuable statements and finish off with a personal opinion.

Pollution from production or transportation can be described as negative externalities. An externality is defined as a positive or negative effect that affects a third party that is not involved in the action that is causing the effect, and is not accounted for in the market price (Rosen and Gayer, 2010).

In some cases of externalities we can think of scenarios where the involved parties through negotiation and bargaining can come to a solution which is efficient (Pindyck and Rubinfeld, 2005). Ronald Coase analysed these opportunities and found out that under strict assumptions a solution between two parties can be achieved (Rosen and Gayer, 2010). These two central assumptions in Coase’s theorem are:

- Property rights must be assigned. Pindyck and Rubinfeld (2005) define property rights as “legal rules stating what people or firms may do with their property.” (Pindyck and Rubinfeld, 2005, pp. 659).

- No transaction costs occur when bargaining. Mankiw and Taylor (2010) define transactions costs as: “the costs that parties incur in the process of agreeing and following through a bargaining”. (Mankiw and Taylor, 2010, pp. 904).

Under these two assumptions an efficient solution is achievable, independently of who is assigned these property rights, as long as the property rights are well defined. The effect is called the Coase Theorem and