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The Problem of Social Cost Revisited

SOME years ago, in a paper entitled "The Problem of Social Cost,"' Professor Ronald Coase asserted and argued for a proposition which has since acquired the convenient sobriquet "the Coase Theorem." The proposition is: That in a world of perfect competition, perfect information, and zero transaction costs, the allocation of resources in the economy will be efficient and will be unaffected by legal rules regarding the initial impact of costs resulting from externalities. Note that there are two claims being made, which it is well to separate for purposes of discussion. The first claim is that, under the conditions described, some efficient allocation of resources will be achieved, whatever the legal rule. The second claim is that, under those conditions, the same efficient allocation will be achieved, whatever the legal rule. I shall refer to the first claim as the "efficiency" thesis and to the second claim as the "invariance" thesis of the Coase Theorem. I shall argue that neither thesis can be deduced from the traditional assumptions about individual economic behavior which are the foundation of neoclassical price theory and contemporary welfare economics.2 Let me be quite clear (or as clear as I can be in advance of presenting my argument)-my primary point is not that the Coase Theorem is false, but that the truth of the Coase Theorem can only be deduced from an assumption or assumptions which differ in kind from the usual assumptions we make about economic agents. The most traditional sort of assumption, and the assumption which is part of every rigorous proof I am familiar with concerning the existence or efficiency of competitive equilibria, is the assumption that each economic agent maximizes something (utility or profit) in the face of prices he takes as given. We depart from this most traditional sort of assumption in the case of the monopolist or the monopsonist-but even the monopolist and the monopsonist operate in an economic environment