Summary
Coase argued that if we lived in a world without transaction costs, people would bargain with one another to produce the most efficient distribution of resources, regardless of the initial allocation. This is superior to allocation through litigation (Coase 1960). Coase used the example of a nuisance case named Sturges v Bridgman, where a noisy sweetmaker and a quiet doctor were neighbours and went to court to see who should have to move. Coase said that regardless of whether the judge ruled that the sweetmaker had to stop using his machinery, or that the doctor had to put up with it, they could strike a mutually beneficial bargain about who moves that reaches the same outcome of resource distribution.
However, many welfare-maximizing reallocations are often forgone because of the transaction costs involved in bargaining (Coase 1960, p. IV, 7). For instance, the sweetmaker may have many neighbors who claim "nuisance" — some legitimate and some not, that the firm would have to sort through, and some of those neighbors who do claim nuisance may try to hold out for excessive compensation. In these cases, the transaction costs eat away, and ultimately eclipse, the price signals that would have led to the most efficient distribution of resources.
In cases like these with potentially high transaction costs, the law ought to produce an outcome similar to what would result if the transaction costs were eliminated. Hence courts should be guided by the most efficient solution.
The ultimate thesis is that law and regulation are not as important or effective at helping people as lawyers and government planners believe.(Coase 1960, p. V, 9) Coase and others like him wanted a change of approach, to put the burden of proof for positive effects on a government that was intervening in the market, by analysing the costs of action (Coase 1960, p. VIII, 23).
The argument forms the basis of the Coase Theorem as labeled by George Stigler.
Read more about this topic: The Problem Of Social Cost
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