Coase Theorem
Given a structure of property rights
which is completely specified,
exclusive, costlessly transferable
and costlessly enforced, voluntary
exchange sill eliminate all Paretorelevant externality and the
resultant allocation of resources will
be independent of any specific
assignment of property rights.
Full liability = Lf ⇒ Acting party
=L =
pays compensation
to affected
party
z
Zero liability = L = affected party
pays bribes to the acting party
z
Assumptions
1. Zero transaction costs
2. Two agents to each bargain
3. Perfect knowledge of each other’s welldefined profits or utility functions
4. Competitive markets for legal entitlements
5. A Costless Court System to uphold all legal
contracts
6. Profit maximizing producers and expected
utility-maximizing consumers
7. No wealth effects or income effects
1
Full liability law + high transaction
costs = total abatement
Zero liability law + high transaction
costs = zero abatement
If assumptions hold, then
Coase Theorem implies:
1.
2.
3.
4.
5.
Market can provide solutions to Paretorelevant externalities
Only role for government is to protect
property rights and reduce impediments to
trade other regulation is wasteful and
unnecessary
Tautology: Implies that status quo is
optional
No difference between payments/subsidies
and taxes/charges
Private property is better than common
property
Even though assumption do not
hold, Coase Theorem valuable:
1. Suggests focus should be on
lowering transaction costs
2. Reducing imperfect information
3. To treat institutions as variables
4. And, to open up new alternatives
such as the trading of pollution
rights. (e.g. facilitate rather than
replace the market alternatives)
2