Ronald Coase

In the past, the premises of the economic theory did not get clear formulation. Developing the theory, the economists often deviated from the study of the foundations, on which it stood. However, this investigation is essential for preventing false interpretations and unnecessary disputes that arise due to insufficient knowledge of the initial assumptions. What is more, in the economic theory, judicious judgment is extremely important for choosing between competing sets of theoretical premises. Ronald Coase’s theories belong to the most important ones in the microeconomics. They had enriched the economic science with various important concepts including the transaction costs and property rights among others. Usage of Coase’s concepts is very effective in the study of economic processes. They make the effective replacement of market exchange of an internal organization possible, which explains the existence of firms. Thus, the paper investigates the biography of Ronald Coase and analyzes his theories and their contribution to the economic though. The aim of these actions is to understand the influence of the scientist’s work on modern life.

Biography

Ronald Coase is a British economist who was awarded the Nobel Prize in Economic Sciences in 1991. He was born on December 29, 1910, in Wilsden, near London. In 1932, he graduated from the London School of Economics. He continued his education at the University of Liverpool and LSE (Schill & Sandor, 2014). During the Second World War, Coase worked as a statistician in the military department. After the war, he returned to the LSE where he received the Ph.D. degree in 1951 (Schill & Sandor, 2014). Since 1951, Coase was a professor at the University of Buffalo, USA, and at the University of Virginia. In 1964, he started to work at the University of Chicago and combined teaching with the editing of the Journal of Law and Economics. After retiring in 1982, he continued active scientific work as a distinguished professor (Schill & Sandor, 2014).

The work Risk, Uncertainty and Profit by Frank H. Knight greatly influenced the formation of Ronald Coase’s interests (Schill & Sandor, 2014). As a result, he became involved in investigating the problem of economic institutions and organizations. Philip H. Wicksteed’s book The Commonsense of Political Economy also had significant impact on Coase’s interests (Schill & Sandor, 2014). While studying in the US, Coase examined the structure of industry. At this point, his interests were determined, and the direction of the future career of an economist was established (Schill & Sandor, 2014).

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Coase’s works are devoted to the market, the functioning of firms, the costs of the market mechanism, the organization of public services, and the institutional structures of economy. Among his works, there are British Broadcasting: A Study in Monopoly (1950), The Firm, the Market, and the Law (1988), and many articles in the Journal of Law and Economics including the classic one “The Problem of Social Cost” (1960) (Schill & Sandor, 2014). Finally, Coase is the author of many theories and concepts that will be analyzed.

Theories and contributions to economic thought

Coase Theorem

In 1960, Ronald Coase published the article “The Problem of Social Cost” where he made the conclusions that George Stigler later named and formulated as “Coase theorem” (Parisi, 2007). Its essence lies in the fact that if the property rights of all parties are carefully defined, and the transaction costs are zero, the final result that maximizes the value of production does not depend on changes in the distribution of property rights (Parisi, 2007). The expression “transaction costs are zero” means that everyone knows everything and recognizes the new things instantly and unequivocally. Coase states that everyone perfectly understands each other; thus, the words are not needed. In addition, this expression implies that everyone has always agreed upon expectations and interests. The author means that if the conditions change, the agreement is instantaneous; any opportunistic behavior is excluded (Parisi, 2007). Besides, there are many interchangeable substitutes of each product or resource.

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In these conditions, the initial distribution of property rights does not affect the structure of production at all since each of the rights will ultimately go to an owner who is able to offer the highest price on the basis of the most effective use of this right (Parisi, 2007). The comparison of the pricing system that includes the responsibility for damage from negative externalities with the pricing system where this responsibility does not exist had led Coase to a paradoxical conclusion; according to the latter, if the participants can agree by themselves, and the costs of the negotiations are negligible because the transaction costs are zero, in the conditions of perfect competition, the maximum possible value of production is achieved in both cases (Parisi, 2007).

However, taking into account transaction costs, one may not achieve the desired result. The fact is that the cost of obtaining necessary information, negotiating, and conducting litigation can exceed the possible benefits of concluding an agreement. In addition, significant differences in consumer preferences are not excluded when assessing damage. For example, one estimates the same damage much higher than another does. In order to consider these differences in the formulation of Coase theorem, the reservation regarding the effect of income was later introduced (Parisi, 2007).

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Coase theorem implies several important theoretical and practical conclusions that contribute to the economic thought. First, it reveals the economic meaning of property rights. According to Coase, externalities, i.e., discrepancies between private and social costs and benefits appear only when the property rights are blurred (Hovenkamp, 2011). When these rights get clear definition, all the externalities are “internalized;” thus, external costs become internal. Not by chance, the main field of conflicts in relation to the external effects is resources that move from the category of unlimited to the category of rare ones. The examples are water and air. Property rights concerning them did not exist earlier at all.

Second, Coase theorem cancels the accusations of market in “fails” (Hovenkamp, 2011). Overcoming the externalities is possible through the creation of new property rights in the areas where they did not get clear definition. Therefore, defective legislation generates external effects and their negative consequences; the aspect that “fails” is the government. Coase theorem removes the standard accusations of environmental destruction, which market and private property often face (Hovenkamp, 2011). The theorem implies the opposite conclusion: not excessive but insufficient development of private property leads to the degradation of the external environment.

Third, Coase theorem reveals the significance of transaction costs (Hovenkamp, 2011). When they are positive, the distribution of property rights ceases to being a neutral factor and begins to affect the efficiency and structure of production. Fourth, the theorem shows that references to external effects are insufficient grounds for state intervention. When the transaction costs are low, the intervention is unnecessary; in case they are high, it is not always economically justified as well (Hovenkamp, 2011). After all, the actions of a state are associated with positive transaction costs themselves. Thus, the “treatment” may be worse than the “disease” itself.

Finally, based on experimental studies, the theorem proves that for qualitative development of market, the competition is vitally important. The competition forces market participants not only to negotiate with each other but also to control the external effects of their activities (Hovenkamp, 2011). Thus, Coase’s transactional approach helped the modern economic theory to acquire greater realism. It had discovered a wide range of business phenomena that were not considered and analyzed previously. Now, it is clear that the most important aspects of managing business is not only the analysis of own economic activity and taking care of production but also the ability and desire to negotiate with the opponents.

The Economics of Property Rights

The economics of property rights is one of the well-known theories of neoinstitutionalism in economy. Ronald Coase was one of the founders of this theory and significantly contributed to its development (Hodgson, 2015). A peculiarity of the approach that concerns the interpretation of property by the authors of the theory as well as its use as a general theoretical and methodological basis of analysis in the economy is that the scientists use not the familiar notion “property” but the term “property right” in their studies (Hodgson, 2015). Thus, a resource itself is not property but, on the contrary, a set or share of the rights to use a resource that the property constitutes.

According to the authors of the theory of property rights, the deprivation of a single entity from free access to certain resources is the specification of its property rights (Hodgson, 2015). Specification of property rights is the assignment of particular powers to one or more economic entities. The aim of the specification is to provide necessary conditions for the acquisition of property rights by those who value them more and are able to obtain maximum benefits from them. The main contribution of Coase to this theory lies in the following statements. If the rights to perform any actions can be sold or bought, people who value the production opportunities, which these rights bring, higher ultimately acquire them. In this case, the acquired rights will be bought, combined, and subdivided in such a way that the activities that they allow would bring the income that has maximum market value (Hodgson, 2015). Thus, the main purpose of the specification of property rights is to regulate the behavior of economic actors so that they make the most effective decisions. It is important to note that only an owner is eventually responsible for all the positive and negative results of his or her activities (Hodgson, 2015). Hence, the owner’s interest lies in conducting the complete and profound analysis of possible results before making any decisions.

Therefore, on the basis of this theory, various types of property rights developed; the examples are private ownership, state ownership, communal ownership, and common ownership (Hodgson, 2015). Besides, the theory contributed to the understanding of the importance of the most efficient allocation of resources. In the process of exchange, the resources move to a more productive user as well as the individuals who value them most.

Law and Economics

Ronald Coase introduced a two-sided view on the law and economics. On one hand, he examined the work of the legal system through utilizing the economic approaches and concepts, which allowed conducting the analysis of the law. On another hand, he investigated the functioning of the economic system from the perspective of the legal system impact. In this way, Coase had managed to develop the subfield of law and economics (Library of Economics and Liberty, 2008).

The following example may explain the above-mentioned statements. There is an agricultural farm and a cattle ranch in the neighborhood. The rancher’s cows can enter the farmer’s fields and cause damage to crops. In this case, the rancher will receive the economic benefits in the form of increasing a total number of livestock while the farmer will face economic disadvantages in the form of reduced crop amount (Library of Economics and Liberty, 2008). Thus, the government can intervene through  defining each participant’s rights and establishing the controlling laws. From another perspective, without legal liability for damaging crops, the rancher and the farmer would have to agree upon economic advantages; the rancher needs to pay the farmer a sum that exceeds the economic benefits of the last and does not exceed his own economic disadvantages (Library of Economics and Liberty, 2008). In this case, they would regulate their legal rights abidance through utilizing economic approaches.

Coase’s opinion forced the economists to look differently at many issues. For example, in case of divorce, such legal barrier as the agreement on distributing the gains from a marriage influences the divorce rate (Library of Economics and Liberty, 2008). The reason for it is that the net gains from marriage can be lower than the desire to get divorced. The law supports the bargaining position of women in court since they get half of the common property but worsens their financial situation like in the case of the rancher.

Coase Conjecture

Coase conjecture concerns an important feature, which the scientist discovered in the theory of industrial markets. The conjecture implies the following: if the number of goods or resources is not limited on the market, the monopolist must sell the product for the price of the market of perfect competition, which is zero profit (Nava & Schiraldi, 2016). Consumers are aware that the amount of goods is not limited, and they decide to wait until the monopolist will have no choice but to lower the actual price to the cost price level. In response, in this situation, the monopolist may try to force the consumers to believe that they will not get a cheap product, for example, through demonstratively destroying some unsold goods (Nava & Schiraldi, 2016).

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Coase conjecture is an argument in monopolistic theory. It implies that the monopolists have to sell their durable products for low prices because the consumers provide their own valuations on the market and may want to wait for the time when the prices will be lower; the monopolists, in their turn, do not know their valuations (Nava & Schiraldi, 2016). Besides, if a monopolist wants to differentiate prices for various classes of consumers, he/she ultimately competes with himself/herself. Thus, in order to avoid this situation and continue to obtain profit, the monopolists must set a stable linear pricing strategy and, thus, cease to be the monopolists. However, the conjecture works only in case of infinite time horizon (Nava & Schiraldi, 2016).

Thus, the Coase conjecture had helped to develop theoretical literature on the obstacles that the monopolists selling durable goods faced on the market in setting prices for these goods (Nava & Schiraldi, 2016). This conjecture showed that the so-called “monopolists” still could not set high prices for their products. Coase’s assumption  was further developed; the scientists had managed to define all theoretical and formal conditions, under which the conjecture could or could not work. It provided the insight into many things starting from the strategic leases to planned obsolescence and the problem of new model introduction (Nava & Schiraldi, 2016).

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Conclusion

In conclusion, the influence of Ronald Coase on the development of economic thought was significant. The new sections of economic science, for example, economics of law appeared due to his works. In a broader sense, his ideas laid the theoretical foundation for the development of the neo-institutional direction of economic theory. Specifically, the Coase theorem revealed the economic meaning of property rights, canceled the accusations of market in “fails”, revealed the importance of transaction costs, and emphasized the insufficiency of state intervention in the economy. In addition, Coase contributed to the development of economics of property rights theory with its concept of providing necessary conditions for the acquisition of property rights by those who valued them more and were able to derive maximum benefits from them. What is more, due to his two-sided view on the law and economics, the economists started to look at many things differently. As a result, the subfield of law and economics developed. Finally, the Coase conjecture helped to understand that the monopolist who sold durable goods could not be considered the monopolist in the original meaning of that term.

 

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