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... the lowest cost avoider will be the part able to reduce damages or the risks of damages at a lowest cost (Brealey & Myers, 1996). As the assumption is that both parties involved in situation can undertake specific actions to prevent damages, it becomes obvious that a Pigou tax could result in significantly worse outcome. For example, it can be assumed that the steel maker is taxed $ 250, 000 per year for the use of his current inefficient steel production methods. In this case, if the steel maker will change his behavior and will decide to adopt newer technology at a cost of $ 150, 000 per year, the situation will be beneficial for the steel maker, and the steel maker will obviously choose to change his behavior, even though it might have be more reasonable for the neighbor office to change. At the same time, under other conditions (for example, if there will be no taxes or liability of the steel maker to the office), that is exactly what could happened.
As it was already mentioned, the transaction cost approach is associated with Ronald Case. The transaction cost basically implies the cost of making a transaction that is not received by the party to a transaction (Buchanan & Stubblebine, 1962). Some examples of transaction cost include but are not limited to the lawyer fees, efforts or time spent on organization processes or negotiation, to mention a few. Transaction costs can be quite high, sometimes substantial enough to make a transaction non beneficial. Reverting to the example with the steel maker and the neighbor office, assume that there is only one steel maker but there are 200 offices in a neighborhood area, and each of the offices incurs $ 300, 000 damage per year. In addition, assume that the steel maker has right to pollute but polluting is not efficient, as the steel maker can change its behavior over a cost of $ 150, 000 per year, versus the neighbor offices $ 70, 000 100 per year.
In this case the offices can contribute $ 1, 500 each. However, some of the offices may avoid paying this amount. Therefore, if 80 of the offices paid $ 1, 875 each, that would be enough to pay off the costs for the steel maker to adopt new technology and stop polluting the air, so the other 20 could refuse to pay. This is referred to as a public good problem. This problem often takes place because it is socially reasonable for everyone to make his contribution, but it is individually reasonable solution for each office owner to try to avoid paying this money. This is a source of transaction costs that may ruin the deal, resulting in inefficient outcome.
Although the Case Theorem has practical significance, most of externalities imply large numbers of individuals. In this case, the assumption of relatively low transaction costs will hardly be satisfied. This also has negative implications on efficiency, as it implies that exchanges that are not all mutually beneficial, can take place. Corollary 1 to the theorem: When transaction costs are high, the assignment of property rights matters for efficiency. (Demsetz, 2003) The following example (the response of tort law to the proliferation of the railroad accidents in the XIX century) can show how the law matters. In case the transaction costs between the victims and the injurers are low, the liability rule will have no impact on efficiency. It will influence only the distribution of wealth.
However, it should be taken into account that the idea of low transaction costs can hardly be realistic. This type of accidents basically implies the accidents between individuals, who are not familiar to each other, who had no or very little chance to bargain before the accident took place. Therefore, the liability rule is supposed to have a relatively significant impact on how much the parties will invest to prevent such accidents. Taking into account the Coase's theory and implications of the theorem, it is possible to conclude that the shift from strict liability to the negligence rule could have offsetting effects on efficiency (Cheung, 1998). At the same time, the negligence is likely to create an incentive for potential victims to be more careful so to avoid the accident happening in the future. In this case, it reduces the accident rate and litigation costs, as it discourages some of the lawsuits.
However, it should be mentioned that strict liability will be better at encouraging the injurers to review their activity level and correct it appropriately (for example, to correct train schedule or to run the efficient number of trains, if necessary), and the costs for litigation of a strict liability case are significantly lower. This example was rather used to show that the rule has impact on efficiency than to point out which rule will be more efficient. The Case theorem and State Intervention As Case theorem asserts, only governments using subsidies or taxes, can internalize externalities in production or economic exchange. In other words, in a bilateral agreement with externalities, there is a possibility for the parties to internalize them by means of negotiation with no external influence when opportunity costs are considered fully. Lets take an example to illustrate this assumption. For example, in case an individual A has negative influence on the individual B (in other words, the effect is an externality), than there is no need for the state intervention.
It means, that the state does not have to intervene and, for example, force both parties to act appropriately. Moreover, when the parties evaluate the possible costs for them, they will have an opportunity to come to an agreement that will be more Pareto efficient for both parties, where Pareto efficient assumes that in a specific situation no person can be improved in standing without affecting someone elses standing. The following example illustrates this argument. For example, there are two buildings located one near another. The musician, who lives in the first building, likes to compose the music with opened windows, so the extremely loud noise reaches the second building, where an office is located. In result, the employees from the office cannot concentrate and work inefficiently, causing damages to their company.
The office would normally earn $ 1, 000 /day but receives only $ 500 /day due to this loud noise, while the musician receives $ 1, 500 /day without any negative impacts from the neighbor office. In this case, the state could intervene and try to protect the employees, which are a natural capital, however, in general the result will still be inefficient (at least, while applying the Pareto principle). Yet, if the musician and the office owner negotiate, the office owner might ask the musician to close the windows while composing music, which is not as important to the musicians. In this case, the office owners income increases, while the musicians income will not be affected much.
The Case theorem will hold true until the transactional costs become too high. For example, the price of hiring the lawyer to create the agreement between the musician and the office owner will be higher than the price earned. In this case, the transaction costs for a person are too high to enter into agreement. Therefore, in such cases, the state would need to intervene and use taxes, incentives or other initiatives to balance the inequality. Conclusion In conclusion it may be said that the Case theorem has great impact on economic thought. While examining the theorem within the context of transaction costs and externalities it should be noted that externalities are the sources of economic inefficiency, but, at the same time, externalities can be fixed potentially through the market (Demsetz, 2003).
The theorem defines two major conditions that are necessary for efficient market solution zero or low transaction costs, and complete property rights. Under certain circumstances these conditions can be approximated (by assigning property rights and, in this case, resulting in creation of a market for externality). However, sometimes it is not feasible (for example, airline companies will not realistically convince and get approval from the homeowners for overflight rights to their houses, despite the fact that these overflights create externalities). At the same time, in attempt to understand why externalities are in equilibrium, it is important to identify why the theorem cannot be valid under specific circumstances. Correcting or rectifying the externality will imply to undertake a set of actions leading to restoration of market conditions so the theorem will hold. In case this cannot be achieved, external quantity regulation, such as control regulation or command may be required.
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Principles of Corporate Finance. New York: McGraw-Hill. Buchanan, J. , & Stubblebine, W. (1962). Externality.
Economica, 29 (3), 371 - 84. Cheung, S. (1998). The Transaction Costs Paradigm. Economic Inquiry, 26 (4), 514 - 21. Case, R. (1960). The Problem of Social Cost.
Journal of Law and Economics, 3 (1), 1 - 44. De Meza, D. (1998). Case Theorem. In P. Newman, The New Palgrave Dictionary of Economics and the Law, Vol. 1. New York: Stockton Press.
Demsetz, H. (2003). Ownership and the Externality Problem. In T. Anderson, & F. McChesney, Property Rights: Cooperation, Conflict, and Law. Princeton, N.
J. : Princeton University Press. Desert, A. (1992). The Pure Economics of the Case Theorem. Eastern Economic Journal, 18, 287 - 304.
Ellickson, R. (1989). The Case for Case and Against Coaseanism. Yale Law Journal, 99, 611 - 630. Farrell, J. (1987).
Information and the Case Theorem. Journal of Economic Perspectives, 1, 113 - 129.
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Research essay sample on 000 Per Year Transaction Costs
