What is the Coase Theorem?

The Coase Theorem is an economic theory that was developed by Ronald Coase. This theory posits that bargaining or negotiation between two parties will lead to an optimal point of allocating a property, regardless of which of the parties holds the property rights. The Coase theorem also maintains that if the rights to a property are clearly defined, an efficient outcome or allocation will be reached when the parties involved negotiating freely and when there are no transaction costs. According to this theorem, a property is eventually allocated to whoever values it most, regardless of who has initial ownership rights over the property.

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Premises of the Coase Theorem

The presence of clear property rights and the absence of transaction costs are the two prevalent criteria in Coases Theorem. In Coases Theorem, the most favorable allocation of property results from effective negotiation or bargaining. A good example is the case of a chef and a veterinary doctor lobbying for the same space to carry out their professional work. After considering the pros and cons of the office space, Coases theorem posits that space is allocated to whoever values it most. An optimal point of allocation occurs when both parties are able to engage in free negotiation without incurring any transaction costs. In this case, the right to ownership on the property does not matter, rather, the individual with a higher value for the property gets the claim or allocation. It is important to know that the Coases Theorem is no longer applicable to transactions or negotiations that entail high costs.

Related Topics

• Network Externality
• Pigovian Tax
• Coase Theorem
• Agglomeration Diseconomies