Coase Theorem

The Coase theorem, attributed to Ronald Coase but implicit in his 1960 paper The Problem of Social Cost, states that if property rights are well-defined and transaction costs are zero, parties will bargain to an efficient outcome regardless of the initial allocation of rights. The theorem is not a claim about the world but a benchmark result: it identifies the conditions under which markets internalize externalities without government intervention.

The theorem's power lies in what it implies when its conditions fail. In virtually all real cases, transaction costs are not zero: they include the costs of identifying affected parties, negotiating agreements, monitoring compliance, and enforcing contracts. When transaction costs are high, the initial allocation of property rights determines the final outcome — which is why legal design matters. The Coase theorem thus does not argue against regulation; it argues that regulation should be understood as a response to transaction-cost barriers, not as a correction of market failure in the abstract.

The theorem is frequently misread by market fundamentalists as proof that private bargaining can solve any externality problem. Coase himself rejected this reading. The theorem is a methodological tool for identifying which cases require institutional intervention and which do not.