Ronald H. Coase is a Nobel laureate economist from the University of Chicago. Coase was born in England and studied commerce at the London School of Economics. Coase’s primary contributions to economics came from his work on the interface between law and economics and his emphasis on transaction costs.
In 1937, Coase published an article that demonstrated the importance of transaction costs in the formation of business organizations. Transaction costs refer to the costs of finding trading partners, negotiating terms of trade, and enforcing these terms. Coase argued that, to plan their production, entrepreneurs must choose between buying resources in markets or forming their own business organizations. Because transacting in markets is costly, entrepreneurs form business organizations with permanent employees and capital so they can avoid the costs of always using markets.
In 1959 and 1960, Coase published articles aimed at changing the way economists think about externalities and efficiency. Externality is a term that refers to the costs and benefits that people experience because of someone else’s activities. An example of a positive externality would be when someone uses a private detective to catch a criminal, which prevents future crime on behalf of would-be victims who did not pay for this service. An example of a negative externality would be the noise heard by those who live near an airport. The airport pays for the costs of fuel, planes, and labor, but not necessarily for the cost of soundproofing walls. Before Coase’s analysis, all economists thought of externalities as deviations from efficient resource allocation and argued that the only way to deal with these problems was through government taxes and subsidies.
Coase argued that externalities are the result of transaction costs. Coase reasoned that if there were no transaction costs, people would bargain over externalities and, in so doing, internalize them. According to the Coase theorem, if transaction costs are zero and property rights are well defined, people bargaining in markets will generate an efficient allocation of resources. For example, people who live in the vicinity of an airport or factory can bargain over local pollution. This is not to say that bargaining will eliminate the noise or other pollution. Rather, bargaining will force the factory or airport to take proper account of this cost.
There are several important implications of this theorem. First, markets can solve externality problems after courts resolve disputes over property rights, no matter which party wins. Second, market institutions that lower transaction costs are vital to the functioning of markets. Third, markets and governments cost something to operate, so resource allocation by both markets and governments fall short of perfection.
Some argue that Coase is unrealistic because transaction costs are never zero. This sort of criticism demonstrates the failure of many to appreciate Coase’s arguments. Coase maintains that economists should focus on comparing alternative institutional arrangements, rather than comparing one set of imperfect institutions to an ideal situation where people enter into trades effortlessly. Coase’s analysis assumed zero transaction costs not because they really are in fact zero, but because this assumption allows one to appreciate their importance.
In 1974, Coase wrote an important article titled “The Lighthouse in Economics.” In this article, Coase challenged the idea that only governments can produce and operate lighthouses. Coase cited examples of privately owned and operated lighthouses in England. Coase saw both private and public lighthouses as imperfect ways of providing lighthouse services to ships.
Coase’s work is unusual as a modern economist because he hardly used any mathematics or statistics. As the editor of The Journal of Law and Economics, Coase tried to move economists away from abstract modeling—what he referred to as blackboard economics. Instead, Coase used verbal logic and descriptive historical analysis to arrive at his conclusions.
Coase retired from the University of Chicago Law School in 1979 and stepped down as the editor of the Journal of Law and Economics in 1982. He was awarded the Nobel Prize in 1991. Coase succeeded in stimulating debate over a number of legal and environmental issues. However, there remain many subtle aspects of his economics that are relatively unknown or misunderstood.
Assurance and Trust; Economics, Chicago School of; Externalities; Law and Economics; Market Failure
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