August 2013 Bar Bulletin
 
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August 2013 Bar Bulletin

A New Framework: The Coase Theorem is OK

By Robert W. Zierman

 

In 1943, Richard Rodgers and Oscar Hammerstein undertook their first collaborative work, "Oklahoma!" Set in the Oklahoma Territory of 1906, this musical provides not just one, but two love triangles.

The first is between farm girl Laurey Williams and the one who should be her beau, ranch hand Curly McLain, as well as the farm hand, Jud Fry. The second love triangle is between Ado Annie and her boyfriend Will Parker, who has returned from a trip to Kansas City where he had won $50 at the rodeo, intended for her dowry. However, he has spent his winnings on trinkets for her, which he resells to Annie's other, albeit reluctant, love interest - Persian peddler Ali Hakim - save for a deadly "girly"-scope, which Fry purchases from Parker with notorious intent.

Not to worry though, economic forces ought to sweep right in and help resolve these dilemmas for Laurey and Annie. This is supposed to occur at a dance and box social. The box social is to support the building of a new schoolhouse, for which eligible ladies prepare a lunch basket to go to the highest bidder. Lucky bidders then have the right to enjoy both the meal and the company of the lady who made the meal. This provides a very clear-cut and rational way for male suitors to competitively signal their interest.

While no longer orthodox and much less politically correct, this seems to be not much more than a fairly straightforward superimposition of Econ 101 on a turn-of-the-20th-Century dating game. Moving beyond this to the favorite intellectual realm of A New Framework's author's most august professor - Thomas Holdych1 - "Oklahoma!" also alludes to one of the most fundamental tenets of law and economics; specifically, the Coase theorem.

It is found in the musical within the context of a single song - "The Farmer and the Cowman." This song indicates that the farmer and the cowman should be friends. Well, why not? The reason relates to cattle grazing. Before becoming the Sooner State, the territory of Oklahoma appears not to have clearly delineated whether a rancher was or was not liable for damage that wayward cattle do to neighboring farmlands.

This is precisely the point of intellectual embarkation of economics Nobel Prize laureate Ronald Coase's 1960 article in The Journal of Law and Economics: "The Problem of Social Cost." The questions his theorem seeks to balance are: Should ranchers be allowed to harm farmers? Or should farmers be allowed to force ranchers to internalize the economic, nuisance externality associated with cattle grazing? What Coase illustrates is that - barring transaction costs - society can be indifferent as to this choice. How?

Coase explains his point by setting up a cost matrix between the rancher and the farmer in this way. The first steer creates one ton of crop loss; two steers create crop loss of three tons; three steers create crop loss of six tons; and four steers create crop loss of 10 tons. Or, put more simply, each steer creates its additive value in crop loss, in progressive fashion such that the number of steers added together equals the total crop loss for that year, i.e., the crop loss effect of four steers equals 1+2+3+4.

Beyond this, Coase provides two other assumptions as analytical bounds. First, the value of each crop ton fetches $1 on the market. Second, the annual cost to fence the land to prevent cattle damage is $9.


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