Law and Economics-Charles W. Upton Property Rights and the Coase Theorem

The Coase Theorem

Property Rights and the Coase Theorem The Coase Theorem Recall the basic Coase Theorem: once property rights are established, the allocation of resources will be Hicks-Kaldor Optimal. The crop loss will be non-optimal if property rights are unclear.

Property Rights and the Coase Theorem The Coase Theorem Recall the basic Coase Theorem: once property rights are established, the allocation of resources will be Hicks-Kaldor Optimal. The crop loss will be non-optimal if property rights are unclear. However, this principle does not hold if transaction costs are high.

Property Rights and the Coase Theorem The Coase Theorem Recall the basic Coase Theorem: once property rights are established, the allocation of resources will be Hicks-Kaldor Optimal. The crop loss will be non-optimal if property rights are unclear. The simple version of the Coase Theorem holds that economic output will be the same no matter what the property rights are. A more general version says the outcome will be efficient.

Property Rights and the Coase Theorem Recall the basic Coase Theorem: once property rights are established, the allocation of resources will be Hicks-Kaldor Optimal. The crop loss will be non-optimal if property rights are unclear. The Coase Theorem The simple version of the Coase Theorem holds that economic output will be the same no matter what the property rights are. A more general version says the outcome will be efficient. Think of the resort and the railroad. Whichever way we assign the property rights will influence income and hence the demand for (say) coal. In turn, the spillover effects will be seen throughout society.

Property Rights and the Coase Theorem The Coase Theorem Some authors talk about social norms as a way of obtaining efficiency without the use of bargaining or property rights.

Property Rights and the Coase Theorem The Coase Theorem Some authors talk about social norms as a way of obtaining efficiency without the use of bargaining or property rights. For example if we all obey the commandment “Thou Shalt Not Steal” on moral or religious grounds, the problem with Farmer A and Farmer B disappears.

Property Rights and the Coase Theorem Transaction Costs We want to allocate resources to their best use, and property rights will help us do that. However, there are Transactions Costs –Search Costs –Bargaining Costs –Enforcement Costs

Property Rights and the Coase Theorem Transaction Costs If Transaction Costs ≈ 0 –Allocation of property rights irrelevant. –Simply allocate property rights and let the bargaining process allocate the property

Property Rights and the Coase Theorem Transaction Costs If Transaction Costs ≈ 0 –Allocation of property rights irrelevant. –Simply allocate property rights and let the bargaining process allocate the property If Transaction Costs >0 –Allocation of property rights matters. We want to get it right.

Property Rights and the Coase Theorem Transaction Costs Can we lower Transaction Costs?

Property Rights and the Coase Theorem Transaction Costs Can we lower Transaction Costs? –To some extent.

Property Rights and the Coase Theorem Transaction Costs Can we lower Transaction Costs? –To some extent. The size of transaction costs depends on whether we are talking about a homogenous or heterogeneous good.

Property Rights and the Coase Theorem Transaction Costs Can we lower Transaction Costs? –To some extent. The size of transaction costs depends on whether we are talking about a homogenous or heterogeneous good. Homogenous Good: one where there are many similar items. (A share of IBM stock or a can of soda). Heterogeneous Good: one where each item is unique. (A house or a piece of land).

Property Rights and the Coase Theorem The Coase Theorem and Transaction Costs Can we lower Transaction Costs? –To some extent. Can we “lubricate” the bargaining process? –To some extent

Property Rights and the Coase Theorem The Coase Theorem and Transaction Costs Can we lower Transaction Costs? –To some extent. Can we “lubricate” the bargaining process? –To some extent Smith owns a piece of land that is worth $100 to him and $150 to Jones. Efficiency requires that Smith sell to Jones

Property Rights and the Coase Theorem The Coase Theorem and Transaction Costs Can we lower Transaction Costs? –To some extent. Can we “lubricate” the bargaining process? –To some extent Smith owns a piece of land that is worth $100 to him and $150 to Jones. Efficiency requires that Smith sell to Jones Alas, they despise each other.

Property Rights and the Coase Theorem Transaction Costs Can we lower Transaction Costs? –To some extent. Can we “lubricate” the bargaining process? –To some extent Smith owns a piece of land that is worth $100 to him and $150 to Jones. Efficiency requires that Smith sell to Jones Alas, they despise each other. Intermediaries, such as lawyers and real estate agents can help get the two together.

Property Rights and the Coase Theorem Transaction Costs Can we lower Transaction Costs? –To some extent. Can we “lubricate” the bargaining process? –To some extent Smith owns a piece of land that is worth $100 to him and $150 to Jones. Efficiency requires that Smith sell to Jones Alas, they despise each other. Intermediaries, such as lawyers and real estate agents can help get the two together. Consider the problem of the Smiths, selling their house of 40 years to move in to a retirement home, and the Wilsons, a young couple considering buying it.

Property Rights and the Coase Theorem The Coase Theorem and Transaction Costs Can we lower Transaction Costs? –To some extent. Can we “lubricate” the bargaining process? –To some extent.

Property Rights and the Coase Theorem The Coase Theorem and Transaction Costs Can we lower Transaction Costs? –To some extent. Can we “lubricate” the bargaining process? –To some extent. Can the legal system get it right when the bargaining system fails?

Property Rights and the Coase Theorem The Coase Theorem and Transaction Costs Can we lower Transaction Costs? –To some extent. Can we “lubricate” the bargaining process? –To some extent. Can the legal system get it right when the bargaining system fails? –To some extent.

Property Rights and the Coase Theorem The Coase Theorem and Transaction Costs Can we lower Transaction Costs? –To some extent. Can we “lubricate” the bargaining process? –To some extent. Can the legal system get it right when the bargaining system fails? –To some extent. Two women claimed to be the mother of an infant

Property Rights and the Coase Theorem The Coase Theorem and Transaction Costs Can we lower Transaction Costs? –To some extent. Can we “lubricate” the bargaining process? –To some extent. Can the legal system get it right when the bargaining system fails? –To some extent. Two women claimed to be the mother of an infant Solomon offered to divide the child in half. The real mother revealed herself by offering to give up the child.

Property Rights and the Coase Theorem The Coase Theorem and Transaction Costs Can we lower Transaction Costs? –To some extent. Can we “lubricate” the bargaining process? –To some extent. Can the legal system get it right when the bargaining system fails? –To some extent. Two women claimed to be the mother of an infant Solomon offered to divide the child in half. The real mother revealed herself by offering to give up the child. Note: Solomon did not make the decision, but used the process to get the women to reveal facts.

Property Rights and the Coase Theorem The Coase Theorem and Transaction Costs Can we lower Transaction Costs? –To some extent. Can we “lubricate” the bargaining process? –To some extent. Can the legal system get it right when the bargaining system fails? –To some extent. Two women claimed to be the mother of an infant Solomon offered to divide the child in half. The real mother revealed herself by offering to give up the child. Note: Solomon did not make the decision, but used the process to get the women to reveal facts. We call this the Wisdom of Solomon.

Property Rights and the Coase Theorem The Coase Theorem and Transaction Costs Can we lower Transaction Costs? –To some extent. Can we “lubricate” the bargaining process? –To some extent. Can the legal system get it right when the bargaining system fails? –To some extent. Two women claimed to be the mother of an infant Solomon offered to divide the child in half. The real mother revealed herself by offering to give up the child. Note: Solomon did not make the decision, but used the process to get the women to reveal facts. Today, information costs are lower. A modern Solomon would simply order a DNA test.

Property Rights and the Coase Theorem The Coase Theorem and Transaction Costs Can we lower Transaction Costs? –To some extent. Can we “lubricate” the bargaining process? –To some extent. Can the legal system get it right when the bargaining system fails? –To some extent. And to some extent, the courts should not try.

Property Rights and the Coase Theorem End ©2004 Charles W. Upton