Economic Thinkers: The Coase Theorem and Prince

by Elaine Schwartz    •    Sep 8, 2013    •    1493 Views

Assume for moment that you are in a college dormitory. You have a final exam tomorrow and someone in a nearby room is playing very loud music. Most of us would say that the music maker has to stop.

Nobel laureate Ronald Coase, who died last week at 102, might have disagreed.

Dr. Coase’s theorem focused on the impact that our activities impose on others. Called an externality, the impact could be positive or negative. When we plant beautiful flowers, the value of our neighbors’ property increases. However, if our factory pollutes the air, the atmosphere suffers. The question that concerned Dr. Coase was what to do about a harmful impact?

In a 1960 essay, “The Problem of Social Cost,” he disagreed with economist A.C. Pigou who suggested taxing whatever was harming people and subsidizing beneficial behavior. It could be emissions or speeding or vaccines. Whether negative or positive, the key was to affect the behavior by increasing or decreasing the cost. (A carbon tax, for example, is a Pigovian tax.)

Responding to Pigou’s conclusions and widespread appeal, Coase said,  “Not being clear, it was never clearly wrong.”

Instead, Coase said, “The problem we face in dealing with actions which have harmful effects is not simply one of restraining those responsible for them. What has to be decided is whether the gain from preventing the harm is greater than the loss which would be suffered elsewhere as a result of stopping the action which produces the harm.”

Coase said to remember that because 2 parties are involved, we have to decide which one should be constrained. Sometimes negotiation between them can lead to an equitable solution. If not, then society has to look at both–not just the party who appears to be suffering.

So maybe Prince or Paul McCartney is the musician practicing in that dorm room near you. Is it more valuable to stop your studying or their work?

Sources and resources: I started with several excellent news articles at businessinsider and The Washington Post that focused on Ronald Coase’s life and ideas. Then, perfectly complementing the overview, Dr. Coase’s Social Cost paper is readable, understandable and thought-provoking (and the source of my Coase quotes). Finally, to hear Dr. Coase discuss his own ideas, this May 2012 econtalk interview has excellent content and is a tribute to what can be accomplished when you are 101.

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