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The Coase Theorem

I'm back. Never thought I could be that occupied and blogging could become such a burden. The hectic routine finally comes to the end and here we are again!

Our Microeconomics textbook ends with a chapter of Market Failure with a small section of Coase Theorem. What fascinated me was the theory is derived from the law case Sturges v Bridgman (1879).

Sturges is a doctor who moved house and built a shed in his garden to carry out his private practice. Bridgman, Sturges' neighbor, is a confectioner who produce sweets in the kitchen for many year before the doctor moved in. Sturges alleged that the noise of the confectioner grinding affected his practice as a doctor and became a negative externality to the neighborhood.

What the court decides was the foundation of Coase theorem where Bridgman can only continue grinding by paying off the doctor's loss. The case can actually be settled via private bargaining. It is conditioned with low transaction costs and clearly defined property rights.

So the Coase theorem states that if property rights are well defined and transactions costs are low, private parties can internalize an externality.


1) Property rights establish the legal owner of a resource and specify the ways in which the resource may be used. 2) Transactions costs are the costs of "doing business", relating to: time, communication, etc. 3) Internalizing an externality is when the (marginal) social and private costs/benefits are brought together.

Screenshot from HBO's miniseries Chernobyl

Since Coase, economist try to valuate the cost of externality. Sometimes it leads the way and sometimes it does not.

In the case of Austria, the country is surrounded by countries that operate a total of 41 nuclear plants. "Two of these plants, located just 35 miles from the Austrian border with Slovakia, share important design features with the ill-fated Chernobyl plant that in 1986 experienced the worst nuclear accident in history.

Given the light of Coase theorem, Austrian officials offered in January 1991 to provide Slovakia with free electric power as an inducement to shut down the two Soviet-designed reactors. Austrian Economics Minister Wolfgang Scheussel estimated that the cost of the replacement power would be about $350 million annually. Czech Premier Marian Calfa expressed interest in the Austrian offer and pledged that a working group would study it. But no agreement was ever reached to implement it. As this experience illustrates, the costs of negotiation sometimes stand in the way even of agreements that would substantially benefit both parties."

Well if it is the case, transaction cost was what to blame for failure of Coase Theorem in Austria. And has it ever been low?


2. Applying the Coase Theorem:

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