Before you read on: why did Ronald Coase think firms exist at all?
Coase argued that using the market has costs, such as agreeing and policing contracts. A firm forms where in-house work is cheaper.
- Lived
- Born 29 December 1910 in Willesden, near London; died 2 September 2013 in Chicago, aged 102
- Nationality
- British-born; moved to the United States in 1951
- Work
- Commerce graduate (1932) and lecturer (1935 to 1951) at the London School of Economics; University of Buffalo (1951 to 1958) and University of Virginia (1958 to 1964); University of Chicago Law School from 1964; editor of the Journal of Law and Economics, 1964 to 1982
- Key works
- The Nature of the Firm (1937); The Federal Communications Commission (1959); The Problem of Social Cost (1960); The Lighthouse in Economics (1974)
- Nobel Prize
- 1991, unshared, for his work on transaction costs and property rights
- School
- A founder of law and economics and of new institutional economics
What Coase was reacting to
Textbook theory counted the costs of making and moving goods. It left out the cost of arranging deals: drawing up contracts, making sure they are kept and managing staff. So theory could not explain why firms exist.
On harm to third parties, such as factory smoke, the standard remedy came from Arthur Pigou: tax whoever causes the harm. Coase pointed out that curbing the harm also costs someone, so the question is which arrangement costs least overall.
In American radio, the Federal Communications Commission handed out frequencies by official decision. Coase asked why they were not priced like other scarce resources.
Coase's key ideas
Can you name Coase's three key ideas?
The costs of using the market, on top of the price itself: agreeing terms, writing a contract and checking that it is kept.
Can you think of an example?
Selling a house means paying solicitors and spending weeks haggling.
A firm replaces many market deals with a manager directing the work. It grows until doing one more task in-house costs more than buying it in.
Can you think of an example?
A news website needing photographs daily may find a staff photographer cheaper than agreeing a fee for every freelance job.
If property rights are clear and can be traded, and bargaining costs nothing, the parties reach the same efficient result whoever the law favours. The legal rule then decides only who pays whom.
Can you think of an example?
Blasting at a quarry kills £8,000 of fish a year at a nearby farm; quieter blasting costs £5,000. If the farm holds the right, the quarry switches. If the quarry holds it, the farm pays it to switch. Either way, the blasting changes.