The Problem of Social Cost

Ronald Coase's 1960 paper, "The Problem of Social Cost", introduced the Coase theorem. This theorem suggests that when transaction costs are low, private parties can negotiate efficient solutions to externalities, regardless of initial liability assignment. An externality is a cost or benefit of a transaction that affects a third party not involved in the deal. For instance, pollution from a factory is a negative externality, imposing costs on the community that the factory owners do not bear. While the Coase theorem highlights the potential for market-based solutions, its assumption of costless negotiation is often unrealistic, leading to government intervention to address externalities.1234