AN EVALUATION OF R.H. COASE'S CONTRIBUTION TO THE THEORY OF THE FIRM AND TO THE PROBLEM OF SOCIAL COST

Abstract

The competitive paradigm describes a frictionless economy where the market is assumed to function smoothly. This characterization depicts an ideal state of affairs which is devoid of real life subject matter. In meeting this criticism, Ronald Harry Cease (1910- ) was among the first in the economics profession to argue that only theories which include transaction costs will be of practical relevance. His proposition that there are costs involved in making a transaction in the market revamps the approach in welfare economics which follows largely from Pigou's analysis, and provides an important insight as to why the firm is preferred under certain conditions to the market as a means of organizing production. With reference to the market, the firm and the law, this dissertation examines the implications of transaction costs for achieving economic efficiency. The introductory chapter begins with a brief bibliographical sketch of Coase and his work. This is followed by a discussion of economic, social and physical factors which influence the magnitude and the type of transaction costs. Coase's contribution to the study of externalities is reviewed in Chapter 2. Firstly, attention is drawn to the reciprocal nature of harmful effects. This is followed by a discussion of the Coase Theorem which posits that private agents will bargain to a joint-maximum when transaction costs are zero. Subsequent discussions examine the implications of positive transaction costs for resource allocation, and the role of the government as an alternative allocative mechanism when prohibitive costs prevent the market from allocating resources optimally. Chapter 3 focuses on the emergence of the firm. An explanation of the factors which tend to limit the growth of the firm is also provided. The latter part of the chapter analyses the efficacy of various contractual arrangements (including vertical integration) which have been designed to take into account the possibility of strategic behavior, shirking and the risk preferences of agents. In addition, the effects of investments types on the tenure of a contract and on the preferred organizational structure are also discussed. A literature survey of studies on property rights which Coase's work on transaction costs has helped to spawn is undertaken in the fourth chapter. It begins with a framework concerning how rights should be assigned to achieve optimal allocation, given positive transaction costs. Other key issues addressed involve the use of the legal system in fostering efficient outcomes when there are asymmetric transaction costs and imperfect information. The fifth chapter is an assessment of Coase's contribution. The chapter includes a rebuttal by Coase to the claim of his critics that efficient bargaining in a world of costless transaction cannot be obtained because of endowment effects, strategic behavior and asymmetric information. Some issues on which Cease thinks he has been misunderstood are also noted. Chapter 6 provides the concluding observations. It also reiterates the importance of transaction costs to the study of the market, the firm and the law.