Better Living Through Economics: Coase Theorem

When I tell people I study economics, I often get one of two responses: 1) “Oh cool, what do you think about…” or 2) “I hated economics in college!”

For the second group, I believe this is because they haven’t been shown the value and relevance of economics.  Many economics courses miss the forest for the trees, leaving students with the impression that economics is mainly about confusing charts.

I believe economics can yield enormous benefits, and I hope to write about that soon in another post.

Here I want to relay a personal story of “better living through economics.”

The Washing Machine

I live in a four-plex where all units share a washer and dryer in the basement.  One of the other tenants discovered the hot water for the washer was connected to her hot water heater.  This meant she was paying for everyone to use hot water for laundry.

She tried to get the landlords/slumlords to fix this but they ignored her.  She was rightly angry and took matters into her own hands, disconnecting the hot water line.  The result is no one in the apartment could use hot water to wash.  While she wasn’t having to foot the bill for everyone’s hot water, this certainly made me worse off.  I either had no hot water or had to go to the laundromat.

A Solution

The next year a different woman moved into the apartment.  I felt obligated to tell her about the hot water issue but I also didn’t like the water being disconnected.

I proposed a deal.  Leave the hot water on and I would pay her $20 a month as compensation.  I got what I wanted (hot water) for a price I was willing to pay ($20).  This transaction made everyone better off.  She didn’t have gas stolen from her, and I didn’t have to go to the laundromat.

I actually got the idea to pay her by thinking about the problem and a famous economic idea, the Coase Theorem.   The Coase Theorem says that if private property rights are well defined and there are zero transaction costs, then exchange will lead to an efficient allocation of resources.

Let me break this down:

The tenant whose hot water was connected to the washer owned the private property rights to the gas.  She was paying for it, and I wasn’t going to steal it.  So, private property rights were well-defined.  Second, the transaction costs were near zero.  I had to go talk to my neighbor, convince her this was a good idea, and then go to the bank and get a $20 bill each month to give her.  These were relatively small transaction costs.  Both conditions for the Coase Theorem were more-or-less met.

Then, I exchanged $20 for the right to use her hot water.  This was a much more economically efficient outcome than having the water disconnected.  I was happy to pay $20 and she was happy to sell her hot water.  After all, it meant she could use the hot water too.  The moral of the story is that economics guided me in how to resolve this problem in a way that benefited all parties.

The Rest of the Story

After the woman I had the agreement with moved out, a couple moved in.  He was a welder.  He also found out about the hot water issue before I could talk to them.  He used his welding tools too to remove the hot water line completely.  Now no one can wash with hot water without having a plumber fix the line.

I think this illustrates how we as people often make ourselves and others worse off by severing (literally in this case) lines of exchange.  Two of my neighbors in their anger shut things down and made everyone worse off.  A little thought would have yielded a simple, mutually-beneficial solution.  Why are we so quick to be heavy handed when a simple exchange can make a big difference?

Advertisements
This entry was posted in Better Thinking, Economics. Bookmark the permalink.

2 Responses to Better Living Through Economics: Coase Theorem

  1. Michael LeGower says:

    See also indoor smoking bans.

  2. Pingback: How “hipsters” are like the pioneers | Not One Square Inch

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s