Coase and the Transaction Cost Approach to Regulation

Early economic research on natural monopoly regulation focused on market failure -- pricing tariffs and externalities. While Coase's multi-tariff marginal cost pricing became the standard, his approach to externality regulation as a contractual issue shifted the debate to transaction costs, but failed to recognize the associated political hazards. The renewed approach to regulation is more cognizant of the interplay of transaction costs and political hazards. In this paper, we show that regulatory rigidities arise as a response to political hazards of opportunistic expropriation and challenges from interested third parties to public agents