The Problem of Social Cost: Fifteen Years Later

Abstract

Coase's work on social cost has rightly had an enormous impact on work in the profession. Confusion or controversy still shrouds many of the issues raised. This chapter discusses a few important issues raised by Coase. As per the Coase theorem, in a world of perfect competition, perfect information, and zero transactions costs, the allocation of resources will be efficient and invariant with respect to legal rules of liability. Perfect competition is best seen not as an assumption of the theorem but as a result of zero transactions costs. Zero transactions costs are equivalent to a guarantee of an optimal set of institutions. If there is any method at all by which a joint maximization process, for example, perfect competition, could be brought about, it would be discoverable and accessible with zero transactions costs. This view of the Coase theorem draws attention to those elements of transactions costs that produced different types of legal and institutional arrangements. Monopoly may, thus, be seen as a product of defects in the institutional structure arising from transactions costs. Its customers would pay enough to eliminate it but do not because of high transactions costs. With zero transactions costs, bargaining with a monopolist could lead to a Pareto improvement by converting the monopolist into a perfectly discriminating one. More importantly, monopoly would be incompatible with the institutions that would grow out of such a world. In this context, optimal antitrust laws and the like may be seen as the product of a zero transactions cost world.