Ronald Coase

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Ronald Harry Coase (b. December 29, 1910) is a British economist and the Clifton R. Musser Professor Emeritus of Economics at the University of Chicago Law School. He graduated from the London School of Economics in 1931. He received the Nobel Prize in Economics in 1991.

Born in Willesden, England, Coase is best known for two articles in particular: "The Nature of the Firm" (1937), which introduces the concept of transaction costs to explain the size of firms, and "The Problem of Social Cost" (1960), which suggests that well defined property rights could overcome the problems of externalities (see Coase Theorem).

Coase's transaction costs approach is currently influential in modern organizational theory, where it was reintroduced by Oliver E. Williamson.

Coase is also often referred to as the "father" of reform in the policy for allocation of the electromagnetic spectrum, based on his article "The Federal Communications Commission" (1959) where he criticizes spectrum licensing, suggesting property rights as a more efficient method of allocating spectrum to users.

Another important contribution of Coase is the "Coase Conjecture": an informal argument that durable-goods monopolists do not have market power because they are unable to commit to not lowering their prices in future periods.

Contents

[edit] "The Nature of the Firm"

The Nature of the Firm was a brief but highly influential essay in which Coase tries to explain why the economy is populated by a number of business firms, instead of consisting exclusively of a multitude of independent, self-employed people who contract with one another. Given that "production could be carried on without any organization [that is, firms] at all", Coase asks, why and under what conditions should we expect firms to emerge?

Since modern firms can only emerge when an entrepreneur of some sort begins to hire people, Coase's analysis proceeds by considering the conditions under which it makes sense for an entrepreneur to seek hired help instead of contracting out for some particular task.

The traditional economic theory of the time suggested that, because the market is "efficient" (that is, those who are best at providing each good or service most cheaply are already doing so), it should always be cheaper to contract out than to hire.

Coase noted, however, that there are a number of transaction costs to using the market; the cost of obtaining a good or service via the market is actually more than just the price of the good. Other costs, including search and information costs, bargaining costs, keeping trade secrets, and policing and enforcement costs, can all potentially add to the cost of procuring something with a firm. This suggests that firms will arise when they can arrange to produce what they need internally and somehow avoid these costs.

There is a natural limit to what can be produced internally, however. Coase notices a "decreasing returns to the entrepreneur function", including increasing overhead costs and increasing propensity for an overwhelmed manager to make mistakes in resource allocation. This is a countervailing cost to the use of the firm.

Coase argues that the size of a firm (as measured by how many contractual relations are "internal" to the firm and how many "external") is a result of finding an optimal balance between the competing tendencies of the costs outlined above. In general, making the firm larger will initially be advantageous, but the decreasing returns indicated above will eventually kick in, preventing the firm from growing indefinitely.

Other things being equal, therefore, a firm will tend to be larger:

  • the less the costs of organizing and the slower these costs rise with an increase in the transactions organized.
  • the less likely the entrepreneur is to make mistakes and the smaller the increase in mistakes with an increase in the transactions organized.
  • the greater the lowering (or the less the rise) in the supply price of factors of production to firms of larger size.

Coase does not consider non-contractual relationships, as between friends or family members.

[edit] "The Problem of Social Cost"

Published in the Journal of Law and Economics in 1960, while Coase was a member of the Economics department at the University of Virginia, "The Problem of Social Cost" provided the key insight that it is unclear where the blame for externalities lies. The example he gave was of a rancher whose cattle stray onto the cropland of his neighbour. If the rancher is made to restrict his cattle, he is harmed just as the farmer is if the cattle remain unrestrained.

Coase argued that without transaction costs it is economically irrelevant who is assigned initial property rights; the rancher and farmer will work out an agreement about whether to restrict the cattle or not based on the economic efficiency of doing so. Property rights allocation will hence matter only in determing distribution.

With sufficient transactions costs however, initial property rights will have a non-trivial effect. From the point of view of economic efficiency, property rights should be assigned such that the owner of the rights wants to take the economically efficient action. To elaborate, if it is efficient not to restrict the cattle, the rancher should be given the rights (so that cattle can move about freely), whereas if it is inefficient to do so, the farmer should be given the rights over the movement of the cattle (so the cattle are restricted).

This seminal argument forms the basis of the famous Coase Theorem.

[edit] The Ronald Coase Institute

Coase is research advisor to the Ronald Coase Institute, an organization that seeks to build the study of markets, with particular support for researchers from underdeveloped countries.

[edit] Further reading

  • Coase, Ronald. "The Nature of the Firm". on-line version.
  • Coase, Ronald. "The Nature of the Firm" in Readings in Price Theory, Stigler and Boulding, editors. Chicago, R. D. Irwin, 1952.
  • Coase, Ronald. "The Problem of Social Cost" in Journal of Law and Economics, v. 3, no. 1 pp. 1-44, 1960 on-line version.
  • Coase, Ronald. "The Nature of the Firm" in Economica, Vol. 4, No. 16, November 1937 pp. 386-405
  • Coase, Ronald. "Durability and Monopoly" in Journal of Law and Economics, University of Chicago Press, vol. 15(1), pp. 143-49, 1972.

[edit] See also

[edit] External links

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Ronald Coase

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