Essential Coase: The Problem of Social Cost
Welcome to the essential ideas of Ronald Coase.
Coase's most important contribution in economics is his work on the role played by transaction
costs, legal rules, and property rights in allowing or impeding the negotiating and
bargaining that individuals do with one another, particularly when trying to resolve conflicts.
Recall from previous videos that transaction costs are those costs
that people and businesses incur when they exchange goods and services. For example,
the financial costs, as well as the time it takes to find someone with whom to exchange,
to negotiate the exchange, and to enforce the agreement and resolve disputes afterwards.
In his famous article “The Problem of Social Cost,”
Coase explained that in a world without these costs, people would be able to
easily negotiate with each other when conflicts arose to arrive at solutions.
But transaction costs do exist in the real world and they do impede
the bargaining that could be used to resolve conflicts. Coase's key insight is that the
level of transaction costs is affected by legal rules, including property rights.
Basically, good legal rules keep transaction costs low and, thus, help keep disputes to a minimum.
Let's explore this complex but incredibly important idea with Coase's original example
of a conflict between a doctor's office located next to a noisy
candy-maker – a case that ended up in court. The conflict arose because it was unclear if
the candy-maker owned the right to make noise, or if the doctor owned the right to be free of noise.
The lack of clarity of property rights meant that neither party knew how to bargain with the other.
When the court declared that the doctor had a right to be free of noise, bargaining became
easy. If the candy-maker valued the opportunity to continue operating noisily, he knew that he
had to purchase that right from the doctor. If the candy-maker didn't value that opportunity
that highly, he knew that he had to cease operations in that building and move locations.
Creating a clear property right within a legal system facilitated
bargaining and prevented further disputes. The insight from Coase—that transaction costs,
property rights and legal rules are critical to determine the degree to which people
can effectively resolve conflicts and use resources efficiently—spawned an entirely
new field in economics and is one of the reasons he was awarded the Nobel Prize.
For more information on Ronald Coase, visit EssentialCoase.org
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