Coase Theorem

In law and economics, the Coase theorem (pronounced /ˈkoʊs/), attributed to Nobel Prize laureate Ronald Coase, describes the economic efficiency of an economic allocation or outcome in the presence of externalities. The theorem states that if trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights. In practice, obstacles to bargaining or poorly defined property rights can prevent Coasian bargaining.

This economic theorem, along with his 1937 paper on the nature of the firm (which also emphasizes the role of transaction costs), earned Ronald Coase the 1991 Nobel Prize in Economics. In this paper, Coase argued that real-world transaction costs are rarely low enough to allow for efficient bargaining and hence the theorem is almost always inapplicable to economic reality. Since then, others have demonstrated the importance of the perfect information assumption and shown using game theory that inefficient outcomes are to be expected when this assumption is not met.

Nevertheless, the Coase theorem is considered an important basis for most modern economic analyses of government regulation, especially in the case of externalities, and it has been used by jurists and legal scholars to analyse and resolve legal disputes. George Stigler summarized the resolution of the externality problem in the absence of transaction costs in a 1966 economics textbook in terms of private and social cost, and for the first time called it a "theorem". Since the 1960s, a voluminous literature on the Coase theorem and its various interpretations, proofs, and criticism has developed and continues to grow.