COASE THEOREM

Jugal K Bhattacharyya
INTRODUCTION
 The Coase Theorem is a legal and
economic theory developed
by economist Ronald Coase
regarding property rights, which states that
where there are complete competitive
markets with no transaction costs and an
efficient set of inputs and outputs, an
optimal decision will be selected.
KEY FACTORS

 The Coase Theorem argues that under the right

conditions parties to a dispute over property rights
will be able to negotiate an economically optimal
solution, regardless of the initial distribution of the
property rights.
 The Coase Theorem offers a potentially useful way to
think about how to best resolve conflicts between
competing businesses or other economic uses of
limited resources.
EXAMPLE

 The Coase Theorem is applied to situations

where the economic activities of one party
impose a cost on or damage to the property of
another party..
 For example, if a business that produces
machines in a factory is subject to a noise
complaint initiated by neighboring households
who can hear the loud noises of machines being
made, the Coase Theorem would lead to two
possible settlements.
 The business may choose to offer financial compensation to the
affected parties in order to be allowed to continue producing the
noise or the business might refrain from producing the noise if
the neighbors can be induced to pay the business to do so, in
order to compensate the business for additional costs or
lost revenue associated with stopping the noise.
 The latter would not actually occur, so the result would be the
business continuing operations with no exchange of money.
CASE - I
 If the market value produced by the activity that is
making the noise exceeds the market value of the
damage that the noise causes to the neighbors, then the
efficient market outcome to the dispute is that the
business will continue making machines. The business
can continue to produce the noise and compensate the
neighbors out of the revenue generated.
CASE - II

 If the value of the business's output of making machines is less

than the cost imposed on the neighbors by the noise, then the
efficient outcome is that the business will stop making
machines and the neighbors would compensate the business for
doing so.
 In the real world, however, neighbors would not pay a business
to stop making machines because the cost of doing so is higher
than the value they place on the absence of the noise.
CONCLUSION

 The Coase Theorem is applied when there are conflicting

property rights.
 The Coase Theorem states that under ideal economic
conditions, where there is a conflict of property rights, the
involved parties can bargain or negotiate terms that will
accurately reflect the full costs and underlying values of
the property rights at issue, resulting in the most efficient
outcome.