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The Ronald Coase Theorem

The Coase theorem comes from the idea that firms exist to reduce costs due to transactions because of exchange and production. This thereby creates efficiency, which individuals cannot capture. In his article about the Federal Communications Commission, he states that without transaction expenses, initial property rights arrangements result I outcomes that are effective economically. This is the Coase Theorem.

Coase therefore provides an alternative to regulation and provision of services by the government by; first illustrating that market on its own can create economically efficient outcomes. He methodically explains that intervention through regulation can sometimes or under certain conditions result in lesser economically effective outcomes. Sometimes these outcomes are actually lesser than the markets can create on their own without government involvement.

Firms are profitable to put up since the price mechanism is expensive. Costs due to the price mechanism can be reduced but cannot be done with totally. This is because of the presence of specialists who sell information. One can also note the expenses of starting and finishing a separate contract. In some markets for example produce exchanges, these expenses are minimal but still present. Firms do not do away with contracts but at least help reduce.

In short, this can be explained as: market operations incur expenses. Organizations enable entrepreneurs to take charge of resources and this thereby helps avoid some costs. This is because the entrepreneur has to do his work at minimal expenses or may obtain factors of production at cheaper prices than the market transactions displaced. The entrepreneur has an option to return to the open market if he or she cannot operate at a lesser cost.

However, the Coase theorem is contrary to the Pigouvian concept that the government increases efficiency by making up for deficits called market failures. Pigou reasons that one party harms a second party by engaging with a third or another party. However, according to Coase, an infringement occurs because of disputes over the use of resources. Thus, preventing one party from harming another is similar to harming the first party.

According to Coase, allocation of property rights is not important as far as efficient economic outcomes are concerned. This is because eventually parties will have a way of obtaining similar outcomes irrespective of how the property rights are assigned, that is irrespective of who gets to sue whom. Coase’s understanding of torts and his explanation of the assumptions or expectations of what legal systems should do during conflicts – increase economic efficiency rather than penalize specific conduct – was a big boost to the field of economics.

Coase’s keen interaction and close study of positive transaction expenses in economic exchange enabled him to make a remarkable conclusion (which he wrote in his article – “The Problem of Social Cost, 1960) that what is transacted on the market is rights to do certain actions and not physical entities, as most economists believe. The legal system is responsible for the rights that individuals possess. This is how definition of private property is a critical part of this analysis.

Conclusively, Ronald Coase has thus helped expand our understanding of why firms exist or why organizations have changed as they have. He has also contributed a lot to understanding how this has shaped public policy.


Coase R., The Nature of Firms and Their CostsThe Problem of Social Cost, 1960


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