Wednesday, November 14, 2007

"Coase Theorem" without the environment

Joshua Gans at CoreEcon comments on a post by Levitt over at Freakonomics.

Both blog posts are worth reading. Undergraduates taking environmental economics courses (especially mine) should think carefully about these posts as they provide a interesting perspective of Coase at work (or not at work).

...and there is no mention of the environment (unless you count the crop fire example Levitt uses).

A Freakonomics Contest: The Coase Theorem Online [Freakonomics]
The Coase Theorem is a somewhat rare species of beast: an economic theory that is both completely counterintuitive and yet often right in practice. The idea is named after Ronald Coase, one of the University of Chicago’s many Nobel Laureate economists. Nearing the age of 100, he may not hear quite as well as he used to, but otherwise he is still going strong, sitting on the Board of Directors of the Becker Center, giving lectures, writing academic articles, and attending the occasional seminar.

The basic idea of the Coase Theorem is that no matter who is assigned property rights, as long as transaction costs are not too high, the efficient outcome will be achieved. In his original article nearly fifty years ago, Coase motivated this idea by writing about the problem of sparks from railroad trains setting wheat fields on fire. We will assume that these fires are very costly, and as such it is best to take action to prevent them from occurring.

My students should know very well the theory and why Coase does not often work in practice.

Levitt then links Coase to online URL ownership assuming that the the URL will eventually end up in the hands of those that value it the most highly (resulting in an efficient allocation of URL names). He then asks for counter examples which Freakonomics readers provide in the comments section.

Gans provides a counter-argument and a link to one of his academic papers.

Domain Ownership Tracking[CoreEcon]

While the Coase theorem says that ownership should track efficiency, market transactions for assets (given that they usually link an asset owner with a single potential buyer) will not necessarily lead to ownership tracking efficiency. Indeed, I demonstrated just that in my 2005 RJE paper on the subject.

Try to follow the arguments in this post carefully.


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