Pareto Efficiency, the Coase Theorem, and Externalities: A Critical View

Abstract

:We offer a critical review of the Paretian definition of efficiency by noting its correspondence with the description of the logic underpinning market relationships. With reference to Ludwig Wittgenstein’s analysis of the value content of tautologies, we discuss the tautological nature of the propositions regarding the efficiency of exchange and market equilibria when there are externalities. We critically review the debate on the Coase theorem, its treatment of externalities, and the contrast with the Pigouvian approach, taking into account the distinction between propositions that are true based on their formal logical structure and propositions that are true with respect to their correspondence to actual states of affairs. We also reveal and discuss the logical inconsistencies — in particular, the one between the Coase theorem and perfect competition — and the practical consequences of the application of Pareto efficiency to the analysis of externalities.