Coase theorem

Coase theorem: zero transaction costs lead to Pareto efficiency

The Coase theorem posits that with zero transaction costs, parties can negotiate to achieve an efficient allocation of resources, even in the presence of externalities. This theorem suggests that the initial distribution of property rights does not matter as long as trade is possible and transaction costs are negligible.

Example

Imagine two neighbors, Alice and Bob. Alice's factory emits pollution affecting Bob's garden. If they can negotiate without any costs, they can reach an agreement where Alice compensates Bob for the damage, leading to an efficient outcome.

Remember this

Understanding the Coase theorem helps economists and policymakers design better systems for addressing externalities and achieving efficient resource allocation in real-world scenarios.

Text adapted from Wikipedia, licensed under CC BY-SA 4.0.

Related concepts

the Modigliani-Miller theorem says

Modigliani-Miller theorem: Capital structure irrelevant in perfect markets

Quantity theory of money

MV = PY equation

Efficient-market hypothesis

Prices reflect all available information

Labor theory of value

Value = Labor required for production

Supply and demand

Market-clearing price where quantity supplied equals quantity demanded

Permanent income hypothesis

Permanent income hypothesis (PIH) focuses on permanent income for consumption decisions

Educational content, not financial advice.

Swipe through 100 ML concepts daily

Open Pocket Polymath