The Coase Theorem

I’ve been coming across a few references to the Coase Theorem, some of which dismiss it out of hand as unrealistic. Perhaps they’ve never read The Problem of Social Cost, but complaining that the environment depicted is unrealistic is not, in itself, a criticism of the theory. Indeed, that is largely Coase’s point – that, in an environment with zero transaction costs, you will always end up with an ideal outcome; but the fact of the matter is that there are never zero transaction costs. Indeed, at the start of section VI, Coase states “The argument has proceeded up to this point on the assumption (explicit in Sections III and IV and tacit in Section V) that there were no costs involved in carrying out market transactions. This is, of course, a very unrealistic assumption.” Coase then goes onto outline how transaction costs – that, those things which exist in the real world – prevent social welfare from being maximized. Indeed, the Coase Theorem is more about stating that transaction costs lower social welfare than it is saying that an optimal outcome will come about via negotiations between two parties.