LAW450

LAW AND ECONOMICS

INDIVIDUAL’S ASSIGNMENT

NAME : NUR FARISYA ADLIN BINTI ZULKIFLI

STUDENT’S ID : 2016239418

GROUP : LWB02C

LECTURER : SIR ADLAN ABD RAZAK

TOPIC : THE COASE THEOREM

QUESTION 1 PART B, APRIL 2011.

According to R.H. Coase, in order to achieve economic efficiency in all our action, we must
weigh the gains that would accrue from eliminating the harmful effects which may arise
from the gains that may accrue from allowing them to continue.

In the light of the above statement, discuss the Coase Theorem.

(20 marks)
 The law of property supplies the legal framework for allocating resources and
distributing wealth. Instead of trying to explain what property really is, an economic
theory tries to predict the effects of alternative forms of ownership, especially the
effects on efficiency and distribution. We shall make such predictions about
alternative property rules and institutions.

Regarding to question, Coase theorem is needed as this theorem helps to

found the economic analysis of law and has won its inventor the Nobel Prize in
economics. Coase theorem is a legal and economic theory that affirms that where
there are complete competitive markets with no transactions costs, an efficient set of
inputs and outputs to and from production-optimal distribution are selected
regardless of how property rights are involved, parties naturally gravitate toward the
most efficient and mutually beneficial income. The Coase Theorem states that where
there is a conflict or property rights, the involced parties can bargain or negotiate
terms that are more beneficial to both parties than the outcome of any assigned
property rights. The theorem also asserts that in order for this to occur, bargaining
must be costless. If there are costs related to bargaining then it will affects the
outcome. The Coase theorem shows that where property rights are concerned,
involved parties do not necessarily consider how the property rights are granted if
they can trade to produce a mutually advantageous outcome.

The Coase theorem can be seen easily through example. It's pretty clear that
noise pollution fits the typical definition of an externality, since noise pollution from a
factory, a loud garage band, or, say, a wind turbine potentially imposes a cost on
people who are neither consumers nor producers of these items. In the case of the
wind turbine, for example, it's efficient to let the turbine make noise if the value of
operating the turbine is greater than the noise cost imposed on those who live near
the turbine. On the other hand, it's efficient to shut the turbine down if the value of
operating the turbine is less than the noise cost imposed on nearby residents.
 Since the potential rights and desires of the turbine company and the
households are clearly in conflict, it is entirely possible that the two parties will end
up in court to figure out whose rights take precedence. In this instance, the court
could either decide that the turbine company has the right to operate at the expense
of the nearby households, or it could decide that the households have the right to
quiet at the expense of the turbine company's operations. Coase's main thesis is that
the decision that is reached regarding the assignment of property rights has no
bearing on whether the turbines continue to operate in the area as long as the
parties can bargain without cost.

Let's say for the sake of argument that it's efficient to have the turbines
operating in the area for example that the value to the company of operating the
turbines is greater than the cost imposed on the households. Put another way, this
means that the turbine company would be willing to pay the households more to stay
in business than the households would be willing to pay the turbine company to shut
down. If the court decides that the households have a right to quiet, the turbine
company will probably turn around and compensate the households in exchange for
letting the turbines operate. Because the turbines are worth more to the company
than quiet is worth to the households, there is some offer that will be acceptable to
both parties, and the turbines will keep running. On the other hand, if the court
decides that the company has the right to operate the turbines, the turbines will stay
in business and no money will change hands. This is simply because the households
aren't willing to pay enough to convince the turbine company to cease operation. The
assignment of rights in the example above didn't affect the ultimate outcome once
the opportunity to bargain was introduced, but the property rights did affect the
transfers of money between the two parties.
 There is also a case regarding to the Coase theorem. The case is Sturges v.
Bridgman.In this case, Sturges is a doctor moved to the next door to a
confectioner,Bridgman, who had purchased sweets for sale in his kitchen for many
years. The doctor constructed a small shed for the purpose of private practice on the
boundary of the two properties. However, the loud noises from the confectioner’s
industrial mortars and pestles could be clearly heard, disrupting his use and
enjoyment of his land and he sought an injunction. The injunction was granted by the
lower court and Bridgman appealed. The court held that if the neighbourhood was
known to be industrial, then it is possible that the decision would be different. The
court does not want to discourage the development of of land for residential purpose.
It shows here that there no Coase theorem here as the dispute between Sturges and
Bridgman can be settled through Coase theorem and they need to apply the zero
transaction costs.

Next, regarding to transaction cost as anything that makes it difficult to trade

or as any cost you have to pay that you are not exchanging for something you value.
For example, if you want to buy a car you have to find someone to buy it from.
Searching for a seller is areal cost, but you don’t really gain any value from paying
that cost. You would have had higher net utility making the same purchase if you did
not have to search for a seller. The exchange has three exchange categories which
are first, an exchange partner need to be located. This involves finding someone
who wants to buy what you are selling or sell what you are buying. Second, a
bargain must must be struck between the exchange partners. A bargain is reached
by successful negotiation which may include the drafting of an agreement. Third,
after a bargain has been reached, it must be enforced. While there are three forms of
transaction costs regarding to there three steps of an exchange which is search
costs, bargaining costs and enforcement costs.
 Besides that, we can see principles of the The Normative Hobbes and Coase
Theorems. Principle of The Normative Coase Theorem focus on the structure the
law so as to remove the impediments to private agreement. Private agreements are
preferred for the simple fact that the parties to the dispute are in the best position to
know how much they each value the property right being disputed. Clear, simple
rights make threat values clear to both parties. The principle is normative because it
offers prescriptive guidance to lawmakers. While principle of The Normative Hobbes
Theorem focus on the structure the law so as to minimize the harm caused by
failures in private agreements for example the coercive threats and the
destructiveness of disagreement. When private negotiation fails the law should
allocate property rights to the party who values them most. By allocating property
rights to the party who values them the most, the law makes exchange of rights
unnecessary and thus saves the cost of a transaction.

Last but not least, the remedies that are available in order to protect the
property rights are either legal or equitable. Legal can be through the payment of
compensatory money damages by the defendant to the plaintiff. These damages are
a sum of money that compensates the plaintiff for the wrongs inflicted on her by the
defendant. The court will determine how much the money that need to compensate
by the defendant. Equitable relief consists of an order by the court directing the
defendant to perform an act or to refrain from acting in a particular manner. This
order is in the form of injuction which is said to enjoin the defendant to do or to
refrain from doing a specific act. Damages are the usual remedy for broken promises
and accidents whereas injunctions is the usual remedy for appropriating, trespassing
or interfering with another’s property. In other words, damages are the remedy for
the law of contracts and injuction for the law of property.

(1371 words)