Does anyone here have a fairly good background in theoretical economics?

[lostinacause]

Does anyone here have a fairly good background in theoretical economics?


I need someone to take a second look at this to see if I made any critical judgment errors.

Coase Theorem and Characterization of Gains From Trade

The Coase Theorem is a part of bargaining theory. It suggests that when there are gains from trade that can be realized, they will be realized so long as transaction costs are less then the gains. In developing policy this theory is important because, based on the how the transaction costs are characterized affects whether the outcome is socially optimal compared to another rights distribution or forced market manipulation.

An issue that I find problematic is that characterization of part of the transaction cost as benefits to society. The reason why this is argued is that the transaction costs go to the individual who is able to do the arrangements for the contract. This does not take into account the next best use for the individual’s resources. Unless the individual has no value to society doing something else ignoring the next best alternative could greatly overstate the value that the transaction adds to society.

Consider a potential trade where the gains to be realized from trade are “G”. Each individual has a time loss cost of “L”. A lawyer could draw up the contract for “C” but would earn a wage “WL=C”. His next best job to earn a wage doing another job “WO”. Each individual would split the gains.

Each individual would get half of the gains from trade
G1=G2= 1/2 (G-2L –C)

Lawyer would get “WO” if not working so the lawyers gains
GL = WL – WO

Net societal benefit is equal to the sum of the benefits of all of the individuals.
GS = G1 + G2 +GL
GS = 2 G1 + GL
GS = G - 2L – C + WL – WO
GS = G – 2L – WO

If the opportunity cost is not considered

GL= WL
GS = G – 2L – C + WL
GS = G - 2L

As a result gains from trade are overstated by the opportunity cost of the best available alternative. While complications can be added such as the effect of greater profits on long term investment and what would happen to other workers if the individual choose the best alternative.

(http://possiblylogical.com/blog/)

[idlisambar]

1. Sounds correct

If the "Coarse theorem" says what you say it says, then I think you are right -- the lawyer could be doing some other productive work, and this is not taken into account by the theorem.

[wli]

2. doesn't look too high-flown to me

The opportunity cost consideration is probably worded out of the theorem somewhere, but as far as interpretation and policy-making, it's a very serious consideration.

[Robert Oak]

3. looks well, read this

If I took this example and extended it, say that one trade gain
G1 is potentially less than say a second trade gain G2...

that's the sort of reasoning I see in this extension. Transaction costs
of the second thing WO implies there is only one attorney to write up the contract.

We all know there are thousands of attorneys, so their is no loss WO,
another attorney simply does that task.

Same as approaching it from G1 versus G2...if one calculated in the differences between those two trade gains as part of the equation,
it doesn't make sense, for the equation and theorem (as I am reading this) applies to one instance in time, not an aggregate
and the equation assumes unlimited numbers of trade gains and unlimited supply of attorneys (transaction costs).

[nick303]

7. Look up 'economic profits' vs. 'accounting profits'

This is the kind of loss they are talking about.

[nick303]

9. I take back what I said

Some of the posts in this thread are worded kind of ambiguously, I get your meaning now.

My apologies

[German-Lefty]

4. Found your mistake

Maybe you're applying Coase's Theorem incorrectly. Coase's Theorem is based on utility being generated from the transaction. It ignores any money/compensation changing hands between parties to facilitate a trade.

Lawyer would get “WO” if not working so the lawyers gains
GL = WL – WO
Keep in mind GL is probably negative, unless the lawyer enjoys writing up the contract more than the alternative of say taking a day off and going fishing (or working for someone else). Writing the contract brings him negative utility. Here's your mistake WL shouldn't be a part of GL since it's payment made to facilitate the trade. So what you want to say is:

Lawyer would get “WO” if not working so the lawyers gains
GL = –WO
your later statement was correct:
GS = G – 2L – WO

Coase's Theorem just says if all parties collectively come out ahead by doing the deal, they'll do the deal. It doesn't have anything to say about payment. We can generally assume that nobody is going to do the transaction at a loss.

I'm not sure I buy the theory. Maybe, part of bargaining is being willing to not do a transaction where you benefit some, in order to force the other side to allow you to benefit more, at the risk of not doing the transaction at all.

[Cloister]

5. Of course that's part of bargaining

Think about buying a car. You're telling me you don't know anyone who's had a deal fall through over a couple of hundred bucks for a $20K (or more) car.

[Name removed]

6. Deleted message

Message removed by moderator. Click here to review the message board rules.

[nick303]

8. I'm not entirely sure what to make of your analysis

What you describe is just not really in the spirit of what Coase's theorem is saying.

The lawyer's fee is merely a transaction cost, and his opportunity cost is not taken into account.