Coase theorem and transaction cost economics in the law

The Elgar Companion to Law and Economics, Second Edition

Volumn , Issue , 2005, Pages 7-39

  Parisi, Francesco ^a  

^a GEORGE MASON UNIVERSITY   (United States)

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References (138)

1. The author would like to express his appreciation for the helpful comments received from Harold M. Demsetz, David M. Levy, Henry G. Manne and Walter E. Williams.
2. R.H. Coase, 'The nature of the firm', 4 Economica 386 (1937).
3. Oliver E. Williamson, The Economic Institutions of Capitalism (New York: Free Press, 1985).
4. In the neoclassical conception of the firm as a production function, labour and capital are symmetrically juxtaposed. Non-standard or complex forms of organization are viewed through the monopoly approach.
5. Williamson, supra not 10, at 7.
6. In an ideal world characterized by unlimited rationality (in the sense of ex ante solution of all possible contingencies) ex ante solution of possible problems in the execution stage can be afforded. In coordinating individual behaviour, if one assumes perfect cognitive competence, as the neoclassical economists do, there is no need to worry about ex post opportunism on the part of the contracting parties. The idea is that the parties can plan for every contingency or possible problem. Williamson refers to this implied contracting process as 'planning'.
7. Whereas neoclassical economics glossed over behaviour by assuming self-interest to be both omnipresent (the classic incentive of capitalist economies) and negligible (thus the lack of any adequate analysis of strategic behaviour and opportunism), new institutional economics places a great emphasis on human behaviour. Indeed, the new institutional economics model suggests that strategic behaviour is infused throughout the contracting process, not only as ex ante self-interest in profit-maximization, but also as ex post opportunism in the execution of an already formed contract. If one assumes opportunism does not exist, there will only be self-interest at the negotiations stage (ex ante). The parties will maximize profits before executing a contract. Once the contract is signed, however, it will be executed in good faith. Even if you have limited or bounded rationality, you can still have asset specificity without exploitation because the promise binds the parties. Once the contract is signed, all problems and contingencies are dealt with on a win-win basis. Williamson refers to this implied contracting process as 'promise'.
8. The new institutional economics looks to ex post activities and investment strategy of the firm. In order to be successful the established firm must often invest in durable, transaction- specific assets. Williamson (supra Note10, at 376) argues that if an established firm has capital assets already in place (sunk costs) in a highly particularized area, potential entrants will be deterred from attempting entrance since the likelihood of success, especially in the short term, is low. Potential entrants will seek more secure investments in non-transaction-specific assets. This is the problem identified by Williamson in the standard entry barrier model where supposedly potential entrants have access to the same long-run average total cost curve as the established firms (ibid., p. 375). This model fails to take account of the different costs associated with specific (k = 0) and non-specific (k > 0) assets (ibid., p. 33) The governance contracting model assumes that assets are not fungible and that firms will make efforts to safeguard their investments.
9. Bounded rationality describes behaviour that is 'intendedly rational but only limitedly so'.
10. Williamson describes opportunism as 'self-interest seeking with guile'.
11. The market can be an adequate basis for contracting in a world where every component of production is redeployable to its next best alternative. In a perfectly competitive market, such redeployment of non-specific assets would result in no loss or gain. However, in a world that includes assets specific to a particular production scheme, redeployment can be either impossible or can result in substantial loss. In such a world, governance is a critical factor and thus the firm becomes a critical alternative means of contracting.
12. Coase began his undergraduate studies at the London School of Economics in 1929, as a candidate for a Bachelor degree in commerce.
13. Arnold Plant was appointed Sir Ernest Cassel Professor of Commerce at the University of London in 1930.
14. A. Plant, 'The economic theory concerning patents for inventions', 1 Economica 30-51 (1934) (presented before the British Association at Leicester, September 1933)
15. A. Plant, 'The economic aspects of copyrights in books', 1 Economica 167-95 (1934) (presented as the Presidential Address to the London Economic Club, 13 March 1934). Both papers are now collected in A. Plant, Selected Economic Essays and Addresses, (London: Routledge and Kegan Paul, 1974).
16. On 21-23 March 1981, a conference jointly sponsored by the Law & Economics Center (at the time located at Emory University and now at George Mason University) and the University of California at Los Angeles intended to bring together the distinguished group of scholars that directly contributed to the birth of the law and economics movement. Present on that occasion were William Adams; Armen A. Alchian; Gary S. Becker; Walter Blow; Robert H. Bork; Ward S. Bowman; Steven N.S. Cheung; Ronald H. Coase; Harold Demsetz; Aaron Director; Milton Friedman; Edward W. Kitch; Benjamin Klein; William M. Landes; Wesley J. Liebeler; Henry G. Manne; Jesse W. Markham; John S. McGee; John H. Moore; Thomas B. Morgan; Sam Peltzman; Richard A. Posner; George L. Priest; Kenneth E. Scott; Bernard H. Siegan; George L. Stigler; Michael J. Trebilcock; W. Allen Wallis; and Richard O. Zerbe. The transcription of the historical discussion was published as E.W. Kitch (ed.), 'The fire of truth: a remembrance of law and economics at Chicago, 1932-1970', 26 Journal of Law and Economics 163 (1983). During that discussion, Coase casually suggested the affinity of methodology and thematic with his teachers and fellow students at the London School of Economics: 'I might add something about Britain. The antecedents to events when I went to LSE have been left out. One has to realize that British economists have never been hostile to the study of law, in fact, they have always encouraged people. They thought that economists ought to study law, or at least they used to. Edwin Cannan, who was the professor that Plant studied with, and also Lionel Robbins . . . was very anxious that economists should study law and supported the development of the law faculty at the London School of Economics. . . . There was a dispute between him [Alfred Marshall] and Maitland about how it should be taught. Essentially, the older generation of British economists were not hostile but welcomed the introduction of law into their studies. However, that influence has really disappeared' (at 215-16).
17. R.H. Coase, 'The institutional structure of production', 82 American Economic Review 713, 715 (1992). The paper represents the lecture delivered by the author upon receiving the Alfred Nobel Memorial Prize in Economics, on 9 December 1991.
18. Plant's quotation was taken from Sir Arthur Salter (J.A. Salter, Allied Shipping Control 16-17 (New York: Garland Publishing, 1921). It is with this exact quotation that Coase starts his analysis on the nature of the firm. See Coase, supra Note2, at 388.
19. Coase, supra Note23, at 716.
20. Coase actually presented some of the elements of his later work in a lecture that he gave in Dundee at the beginning of October 1932. But the anticipation was mainly regarding his theory of the firm. A full account of these events can be found in O.W. Williamson and S.G. Winter (eds), The Nature of The Firm: Origins, Evolution, and Development 34-5 (Oxford: Oxford University Press, 1991).
21. R.H. Coase, 'The Federal Communications Commission', 2 Journal of Law and Economics 1 (1959).
22. The reference is obviously to A.C. Pigou, The Economics of Welfare (Brooklyn, NY: AMS Press, 1920), particularly to the analysis contained in the second part of the fourth edition of 1932, on the theme of externalities.
23. G.J. Stigler, Memoirs of an Unregulated Economist 75-6 (Chicago: University of Chicago Press, 1988).
24. Coase recalls that he was urged to omit that section of his FCC article, something that he refused to do. R.H. Coase, 'Law and economics at Chicago', 36 Journal of Law and Economics 239, 249-50 (1993): '[The] discussion of the rationale of property rights, with its attacks on A.C. Pigou, was, however, thought to be erroneous by the economists at Chicago. I was even urged to omit this section from the FCC article. But I refused, arguing that, even if my argument was an error, it was a very interesting error. . . . Had it not been that these Chicago economists thought that I had made a mistake in the article on "The Federal Communication Commission", it is probable that "The Problem of Social Cost" would never had been written'.
25. R.H. Coase, 'Notes on the problem of social cost', in The Firm, the Market, and the Law 157 (Chicago: University of Chicago Press, 1988).
26. Coase recognizes the merit of G.J. Stigler, The Theory of Price 113 (3rd edn, London: Macmillan, 1966) [hereinafter Stigler, Theory of Price].
27. The argument was subsequently restated in, G.J. Stigler, 'The law and economics of public policy: a plea to the scholars', 1 Journal of Legal Studies 1, 12 (1972) [hereinafter Stigler, 'Law and economics of public policy'].
28. It is sufficient here to cite H. Demsetz, 'The exchange and enforcement of property rights', 7 Journal of Law and Economics 11 (1964) [hereinafter Demsetz, 'Enforcement of property rights']
29. H. Demsetz, 'Toward a theory of property rights', 57 American Economic Review 347 (1967) [hereinafter Demsetz, 'Theory of property rights']
30. G. Calabresi, 'Transaction costs, resource allocation and liability rules. A comment', 11 Journal of Law and Economics 67, 68 (1968).
31. See F.R. Shapiro, 'The most cited Law Review articles', 73 California Law Review 1540 (1985).
32. H.G. Manne, The Economics of Legal Relationships 123-6 (1975).
33. In order to verify the prior monopoly of the Pigouvian approach in the treatment of this issue, see F.H. Knight, 'Some fallacies in the interpretation of social cost', 38 Quarterly Journal of Economics 582 (1924), reprinted in Readings in Price Theory 160 (G.J. Stigler and K. Boulding eds, Chicago: R.D. Irwin Publishing, 1952)
34. W. Fellner, 'External economics and diseconomies', 33 American Economic Review 493 (1943), reprinted in Readings in Price Theory 242
35. T. Scitovsky, 'Two concepts of external economics', 62 Journal of Political Economy 143 (1954)
36. Further reference citations are J.E. Meade, 'External economies and diseconomies in a comparative situation', 62 Economic Journal 54 (1952)
37. O.A. Davis and A. Whinston, 'Externalities, welfare and the theory of games', 70 Journal of Political Economy 241 (1962)
38. J.M. Buchanan and W.C. Stubblebine, 'Externality', 29 Economica 371 (1962)
39. R. Turvey, 'On divergences between social cost and private cost', 30 Economica, 309 (1963)
40. More recently, see also W.J. Baumol and A.S. Blinder, Economics: Principles and Policy (3rd edn, New York: Harcourt, Brace Jovanovich, 1985), particularly, chs 27 and 31. For a historical retrospective of the Marshall-Pigouvian tradition
41. see, among others, M. Blaug, Economic Theory in Retrospect 370-424 (4th edn, Homewood, IL: Richard D. Irwin, 1980).
42. For an influential study of the theme of externalities, almost contemporaneous with the contribution of Coase, and exemplifying the diverse approach utilized at the time, see Buchanan and Stubblebine, supra Note37.
43. Coase, supra Note2, at 39. The reference is, again, to Pigou, supra Note29.
44. Both Knight and Fellner had critically examined the theme of externalities, and their analyses were certainly conducive to a free market solution to external economies. Fellner, supra Note37, at 510, acutely observed: 'Where there are genuine diseconomies ignored by the competitive producer - smoke nuisance, wasteful exploitation of resources, etc. - these results follow not from the atomistic character of production, but from technical or institutional circumstances as a sequence of which scarce goods are treated as though they were free; and the divorce of scarcity from effective ownership may be equally complete for atomistic, oligopolistic, and monopolistic private enterprise'. Coase acknowledges the role played by Knight's paper 'Some fallacies in the interpretation of social cost' (supra Note37), in the formulation of his 1960 article: 'I would say that the title of my paper came from Frank Knight. . . . If there are traces of what Knight says in my work, it wouldn't surprise me' (see Kitch supra Note22, at 215).
45. Stigler, Theory of Price, supra Note33, at 113. Such a formulation, in its brevity, contains every element of the Coasean analysis. On one side, the presence of perfect competition provides the existential condition of Coase's model; on the other side, the coincidence of private costs and social costs indicates the complete internalization of externalities. I hope to develop both these themes in the discussion that follows.
46. Demsetz, 'Theory of property rights', supra Note34, at 349.
47. Calabresi, supra Note34, at 68.
48. In his 'Notes on the problem of social cost', supra Note33, at 160, Coase once again uses the citation of an influential economist of the last century whose writings provided - in his formative years - the principle source of inspiration for the successful formulation of his theorem. This source is Francis Y. Edgeworth, Mathematical Psychics (London: C. Kegan Paul, 1881), in which the author argues that the exchange of goods between two individuals will always take place along the so-called 'contract curve' (that is, the aggregate of the best possible combinations of exchange). If it were not like this - the argument continues - the possibility of different wealth-improving agreements would remain open, with the reciprocal advantage for each of the contracting parties.
49. For yet another analysis on the validity and the limits of this analogy, see generally, Demsetz, 'Enforcement of property rights', supra Note34.
50. In line with Edgeworth's reasoning, an important proposition of the Coase theorem has been to affirm that while the legal system establishes the initial allocation of rights and liabilities, in the end it is the dynamic of the market to determine their final allocation. Whenever the initial allocation is not optimal, the owners of the rights will have an incentive to transfer them to other individuals who value them more. Such an exchange will continue until there is no further room for reciprocal profit. As we learn from microeconomic theory, the potential for reciprocal benefit in the exchange will not be exhausted until each right is in the hands of the highest valuing individual. The Coase theorem, thus, predicts that in a competitive market environment without transactional impediments, the final allocation of transferable rights cannot be improved upon.
51. According to this understanding of the Coase theorem, in order to guarantee the efficiency of the system, it is enough to remove every legal and material impediment to the free transfer of individual rights. As R. Cooter observes in 'Coase theorem', in 1 The New Palgrave. A Dictionary of Economics 457 (J. Eatwell, M. Milgate, P. Newman eds, London: Macmillan, 1987), one of these impediments - perhaps that of the greatest interest to the jurist - can be identified in the existence of uncertainties regarding the content of the rights. An imprecise definition of such content renders its valuation and exchange problematic. Similarly, situations of legal instability (inducing uncertainty with respect of future laws) may occasion informational asymmetries delaying the process of reallocation of legal entitlements. The transferability of some subjective legal positions finds different constraints in different legal systems.
52. On the issue of freedom of object in contractual agreements, see M.J. Trebilcock, The Limits of Freedom of Contract (Cambridge, MA: Harvard University Press, 1993). Generally, in order for the conditions for the free exchange to be verified in Coase's model, it is necessary to define the content of the rights without ambiguity, and to provide legal means to enforce their transfer. For further analysis, see also Demsetz, 'Enforcement of property rights', supra Note34; and Demsetz, 'Theory of property rights', supra Note34.
53. The occasion was the First Annual Meeting of the American Law and Economics Association, held in Champain-Urbana (Illinois) on 24-25 May 1991. Those who had the good fortune to be at that meeting will never forget the affable presence of Professor Coase, who agreed to be the first of the four authoritative speakers only after ascertaining that the chosen criterion, age, called upon him to open that historical event.
54. Among the principle sources of this criticism see S. Wellisz, 'On external diseconomies and the government assisted invisible hand', 31 Economica 345 (1964)
55. G. Calabresi, 'The decision for accidents: an approach to non-fault allocation of costs', 78 Harvard Law Review 713 (1965).
56. Among these, see D.H. Regan, 'The problem of social cost revisited', 15 Journal of Law and Economics 427, 431-3 (1972)
57. G.W. Nutter, 'The Coase theorem on social cost: a footnote', 16 Journal of Law and Economics 503 (1968).
58. For this variation on the general theme of distributional effects, see again, Wellisz, supra Note49; and Calabresi, supra Note49.
59. The citations on this point would be overwhelming. In holding most references for the discussion that follows, at this point it is sufficient to cite Cooter, supra Note47, at 457, who analogizes a transaction without costs to an unattainable theoretical model, such as a plane with no air resistance in physics. The assumption of no transaction costs, according to Cooter, calls for the adoption of a legal rule capable of minimizing the costs necessary for the transfer of the right. According to this reading of the Coase theorem, legislators will be freed from allocative concerns, but they would remain burdened with the important task of promoting the elimination of legal and fiscal impediments to the free exchange of rights in the market. In a word, voluntary transfers of entitlements should be encouraged, and every effort should be made to reduce the risk and costs associated with subsequent litigation.
60. Calabresi, supra Note49. For a substantial change in his views on this point, see Calabresi, supra Note34.
61. Wellisz, supra Note49, at 345.
62. Calabresi, supra Note34.
63. Calabresi, supra Note49, at 730-31; and G. Calabresi, 'Fault, accidents and the wonderful world of Blum and Kalven', 75 Yale Law Journal 216, 231-2 (1965).
64. Calabresi, supra Note34, at 67.
65. H.M. Demsetz, 'When does the rule of liability matter?', 1 Journal of Legal Studies 13 (1972).
66. Regan, supra Note50, at 432-3.
67. Stigler, 'Law and economics of public policy', supra Note33, at 12.
68. Regan, supra Note50, at 431-2; and Nutter, supra Note50.
69. Calabresi, supra Note49.
70. Wellisz, supra Note49.
71. For additional arguments on the existence of distributional effects, see P. Burrows, 'On external costs and the visible arm of the law', 22 Oxford Economic Papers 39 (1970)
72. E.J. Mishan, 'The economics of disamenity', 14 Natural Resources Journal 55, 62-4 (1974). With partially different conclusions, see Regan, supra Note50, at 433, according to whom there are wealth transfers only in the presence of individual gains not reflected in the price of the legal entitlement.
73. For a discussion of the problem of social cost that preceded Coase's analysis, see Knight, supra Note37.
74. Coase, supra Note33, at 171.
75. The key here might be that the assumption of zero transaction costs ideally implies that the affected parties have perfect knowledge of expected fluctuations in the system of property rights. This means that the affected parties are never surprised by a legal change, and can fully protect themselves from any wealth redistribution. See Coase, supra Note33, at 171-2.
76. This analysis by Coase seems to rely on the earlier study of S.N.S. Cheung, 'Transaction costs, risk aversion, and choice of contractual arrangements', 12 Journal of Law and Economics 23 (1969).
77. Coase, supra Note33, at 172-3. On this point, the logic of Coase's analysis has been criticized for lack of practicality. The inevitable increase of transaction costs tied to a similar contractual mechanism, has been pointed out by O.E. Williamson, 'Contract analysis: the transaction cost approach', in The Economic Approach to Law 39 (P. Burrows and C.G. Veljanovski eds, Burlington, MA: Butterworth-Heinemann, 1981). Coase appears to be aware of the practical difficulties of such a contractual dynamic. Even though stressing the limited significance of the criticism, Coase, supra Note33, at 174, concedes: 'It cannot be denied that it is conceivable that a change in the criteria for assigning ownership to previously unrecognized rights may lead to changes in demand which in turn lead to a difference in the allocation of resources, but, apart from such cataclysmic events as the abolition of slavery, these effects will normally be so insignificant that they can safely be neglected. This is also true of those changes in the distribution of wealth which accompany a change in the law when there are positive transaction costs and it is too costly for the contracts to cover all contingencies'.
78. Alternative schemes of compensation for losses occasioned by changes in the legal rule have been examined by G. Tullock, 'Achieving deregulation - a public choice perspective', Regulation 50 (November/ December 1978)
79. J. Quinn and M.J. Trebilcock, 'Compensation, transition costs and regulatory change', 32 University of Toronto Law Journal 117 (1982)
80. more extensively, by J.L. Knetsch, Property Rights and Compensation: Compulsory Acquisition and Other Losses (Dublin: Butterworths, 1983).
81. Calabresi, supra Note49.
82. Wellisz, supra Note49.
83. The transaction cost literature seldom differentiates between no transaction cost, which is a theoretical construct, and low transaction cost, which may often be a real-world phenomenon. Many commentators seem to discuss Coase's assumptions without ever defining which situation they are addressing. In the absence of transaction cost, there are no strategic or factual impediments to bargaining, property rights are perfectly defined, and information is costless. The debate on the point will greatly benefit from a more clear distinction between information and negotiation costs, on the one hand, and the costs created by strategic bargaining on the other.
84. For an interesting perspective on the role of contractual strategies in the area of externalities, see also Davis and Whinston, supra Note37, at 241-62.
85. For a subjectivist approach to this problem in a low transaction cost setting, see J.M. Buchanan, 'Rights, efficiency, and exchange: the irrelevance of transactions cost', in Economics: Between Predictive Science and Moral Philosophy 153 (College Station, TX: Texas A&M University Press, 1987).
86. Demsetz, supra Note59, at 21.
87. The entire analysis presupposes that the so-called 'income effect' can be ignored. In general, a different allocation of property rights implies a different distribution of wealth between the individuals involved. Different initial endowments generate different final allocations, notwithstanding an equal level of efficiency. In order for the final allocations to be identical, it is necessary that the utility functions of the individuals involved are almost linear. The absence of the income effects implies, in this sense, that the demand functions for the good are independent of the income level.
88. On this point, see as well the discussion of Calabresi, supra Note34, at 68.
89. In game theory, such a threat in the strategy would be classified as a non-credible threat. The availability of information as to the costs and the benefits of the other contracting party is necessary in order to ascertain the credibility of the threat of others. Nevertheless, in situations of incomplete information, it is possible to have some indicia to evaluate the credibility of the adverse strategy. The game-theoretic literature on the subject is plentiful.
90. On the limits of contractual strategies found in the competitive structure of the market, see M. Shubik, Strategy and Market Structure (New York: Wiley, 1959).
91. Economists classify these situations of economic advantage as situations of rent. See Wellisz, supra Note49, at 345-62, who conducts a first investigation on the theme of rents and their connection with the model of Coase. See also Coase, supra Note33, at 163-70. The content of Coase's analysis on the point will emerge in the course of this chapter.
92. Demsetz, supra Note59, at 24.
93. Most recently, Mancur Olson, 'The Coase theorem is false?', presented at the May 1997 American Law and Economics Association Annual Meeting held in Toronto, Canada.
94. For a retrospective assessment of the role played by his transaction cost paradigm, see the introductory chapter of R.H. Coase, The Firm, the Market and the Law 6 (Chicago: University of Chicago Press, 1988).
95. On this point, see R. Cooter and S. Marks, 'Bargaining in the shadow of law: a testable model of strategic behavior', 11 Journal of Legal Studies 225, 242 (1982).
96. Here it is enough to think of the transaction costs that are in all likelihood necessary in order to reach an agreement between an elevated number of distant parties.
97. Cooter, supra Note47, at 457-58. According to the author, the problem of information costs should be addressed within the broader framework of perfectly competitive markets. See also R. Cooter, 'The cost of Coase', 11 Journal of Legal Studies 1 (1982)
98. As evidenced by O. Schultze, The Public Use of Private Interest (Washington, DC: The Brookings Institution Press, 1977), market structures different from that of perfect competition can be an obstacle to the market dynamic contemplated by Coase. According to Schultze, therefore, the legal system will have to foster the conditions for a healthy competitive market for the transfer of rights.
99. On the point, see more generally C.J. Dahlman, 'The problem of externality', 22 Journal of Law and Economics 148 (1979).
100. For an influential and, yet, controversial examination of the problem, see Williamson, supra Note74.
101. Demsetz, supra Note59, at 20.
102. This example is borrowed from A.M. Polinsky, An Introduction to Law and Economics, 11-14 (2nd edn, Boston, MA: Little, Brown, 1989), who examined the significance of Coase's analysis in the presence of positive transaction costs.
103. We shall observe later that clean air - in economic terms - is a public good, lacking the features of excludability and rivalry in their use, which instead characterizes private goods. In situations of this kind, there is little viability for a market solution to externalities. For a systematic investigation on the theme, see R. Cornes and T. Sandler, The Theory of Externalities, Public Goods, and Club Goods (Cambridge: Cambridge University Press, 1986).
104. The industry, having to choose between paying damages to his/her neighbours ($750), the acquisition of five dryers ($500) or the installation of a filter ($300), will rationally opt for the last possibility, being the most economical. Thus, the efficiency of the result will not be altered in the presence of positive transaction costs. Further proof can be found in Polinsky, supra Note96.
105. Among the various attempts to reformulate the Coase theorem in the presence of positive transaction costs, see again Polinsky, supra Note96. Calabresi, supra Note34, at 72-3, observes that many authors read the Coase theorem as if it suggests that the absence of public intervention is in reality the major cure for externalities. Calabresi does not share this common interpretation, observing that Coase's analysis offers invaluable instruments for the choice of liability rules and for the identification of the areas in which public intervention becomes desirable.
106. The unusual example is not the license of this author but is in fact provided by Coase himself, supra Note33, at 175.
107. Coase, supra Note31, at 251-3.
108. Coase, supra Note2, at 18. Coase criticizes some economists and policy makers for overestimating the advantages of government regulation.
109. Coase, supra Note33, at 174.
110. Coase, supra Note2.
111. Coase, supra Note31, at 251.
112. In this direction, see again, Calabresi, supra Note34, at 72-3.
113. See Polinsky, supra Note96, at 14.
114. Coase, supra Note33, at 178-9. For a discussion on the point, see R.O. Zerbe, 'The problem of social cost: fifteen years later', in Theory and Measurement of Economic Externalities 29, 33 (S.A.Y. Lin (ed.) Academic Press: 1976).
115. For an excellent study on this point, see S. Cheung, 'The structure of a contract and the theory of a non-exclusive resource', 13 Journal of Law and Economics 49, 49-70 (1970).
116. Here reference is made to all those goods which lack excludability in their enjoyment. For further analysis, see again Davis and Whinston, supra Note37; Turvey, supra Note37; Demsetz, 'Enforcement of property rights', supra Note34. The nature of public goods creates problems for the functioning of the price system. In the typical example of a public good, the lighthouse that each sailor utilizes, but for which no one is willing to pay, the market is incapable of inducing consumers to reveal their preferences through prices. Consequently, the supply of public goods will not be induced by the consumers' demand, but will be determined by public choices. Each person will consequently be in a position to derive a benefit from these goods, even though they are not contributing to its cost. More attentively on the subject, O. Davis and A. Whinston, 'On the distinction between public and private goods', 57 American Economic Review 360 (1967)
117. P.A. Samuelson, 'The pure theory of public expenditure', 36 Review of Economics and Statistics 387 (1954).
118. Coase himself discusses the problem in 'The lighthouse in economics', 17 Journal of Law and Economics 357 (1974).
119. For a recent argument against this common belief, see the excellent study by F. Foldvary, Public Goods and Private Communities, the Market Provision of Social Services (Cheltenham: Edward Elgar, 1994).
120. Economic literature prefers to speak of nonrivalry, describing this characteristic as the absence of an increase in the marginal costs of production as an effect of a marginal increase in the number of users. The example often used is that of a tract of interstate road with low traffic, which is fit to satisfy the need of an additional user at no additional cost. For a further analysis, see R.S. Pindyck and D.L. Rubinfeld, Microeconomics, 638-41 (Prentice Hall: 1989).
121. For further ideas on the problem, see S.H. Gordon, 'The economic theory of common property resources: the fishery', 62 Journal of Political Economy 124 (1954).
122. In economic terms, the assumption is that the single economic agent is a price taker, incapable of influencing the prices in the market with his/her own decisions. In an ideal market of atomistic competition, each producer offers a small fraction of the total supply of the market, so that the choice of the quantity produced or demanded by the individual agent will not have any effect on the price of the product. The price will be, instead, determined by the aggregate supply and demand curves.
123. Coase, supra Note33, at 185.
124. Coase is certainly not the only author to denounce this shortcoming of the Pigouvian approach. Many authoritative economists have contributed to the understanding of the limits of this solution. The citations would be lengthy and hardly relevant for the analysis conducted here. For a representative sample, see J.M. Buchanan, 'Politics, policy and the Pigouvian margins', 29 Economica 17 (1962)
125. C. Plott, 'Externalities and corrective taxes', 33 Economica 84 (1966)
126. E.J. Mishan, 'Reflections on recent developments in the concept of external effects', 31 Canadian Journal of Economics and Political Science 3, 33-4 (1965)
127. For the applicative difficulties of the system of Pigouvian taxes in the hypothesis of goods with joint supply, see also, J.M. Buchanan, 'Joint supply, externality, and optimality', 33 Economica 404 (1966).
128. Coase does not examine the difficulties of a political nature connected with the adoption of a system of Pigouvian taxes.
129. Cornes and Sandler, supra Note97, at 59.
130. Coase's argument on the point seems to be refuted by various empirical psychological studies. While rules must always be balanced, the human psyche seems to value current entitlements more than their market price (that is, the actual consumers' surplus is not captured by the objective market price). On the point, see D. Kahneman, J.L. Knetsch and R.H. Thaler, 'Experimental tests of the endowment effect and the Coase theorem', 98 Journal of Political Economy 1325-48 (1990), where the authors explain how measures of willingness to accept greatly exceed measures of willingness to pay. They call this phenomenon the 'endowment effect'. They use this notion to explain the observed undertrading of entitlements in a Coasean setting.
131. For an introduction to this literature, see E. Hoffman and M.L. Spitzer, 'Symposium on law and economics: experimental law and economics. An introduction', 85 Columbia Law Review 1037 (1985)
132. R.E. Scott, 'Error and rationality in individual decision-making: an essay on the relationship between cognitive illusions and management of choices', 59 Southern California Law Review 329 (1986)
133. R.C. Ellickson, 'Bringing culture and human frailty to actors: a critique of classical law and economics', 65 Chicago-Kent Law Review 23 (1989)
134. R.L. Hausen, 'Comment: efficiency under informational asymmetry. The effects of framing on legal rules', 38 University of California-Los Angeles Law Review 391 (1990).
135. Coase, supra Note33, at 180.
136. Coase, supra Note2, at 18-19.
137. T.S. Kuhn, The Structure of Scientific Revolutions (2nd edn, Chicago: University of Chicago Press, 1970).
138. H.G. Manne, The Intellectual History of George Mason University School of Law 4 (Arlington, VA: Law and Economics Center Publication, 1993).