Ronald Coase viewed his own work on externalities not as an end in itself, but as a foundational 'stepping stone' toward a more comprehensive analysis. His ultimate goal was to understand the functioning of an economy where transaction costs are positive and have a significant impact.

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According to Ronald Coase, the practical relevance of private bargaining is fundamentally dependent on transaction costs. These are impediments to achieving a Pareto-efficient outcome, encompassing expenses like legal fees, negotiation costs, and information acquisition. Coase highlighted that when these costs are prohibitively high, private bargaining is likely to fail, making it an impractical solution even if property rights are clearly established.

Transaction Costs in Coasean Bargaining

To cite the ebook, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/.

To cite a unit, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/ Unit [unit number] (url).

CORE Econ - The Economy 2.0: Microeconomics

Transaction costs frequently stem from information asymmetry between negotiating parties. For instance, if one party cannot discover the true extent of the harm caused by an externality, the affected party has an incentive to overstate the costs to secure a more favorable deal. The process of trying to determine the actual costs and benefits for each party is a significant transaction cost in itself, and if it proves too high, it can prevent a bargain from being made.

Information Asymmetry as a Source of Transaction Costs

A common misreading of Coase's work is that it proves government intervention is unnecessary for achieving Pareto efficiency. Coase's actual claim was that this holds true only in the unrealistic, theoretical world of zero transaction costs.

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