The Problem of Social Cost (1960) by Ronald Coase is an article that emphasizes the economic rights of externalities. He draws on a series of English legal cases and statutes to illustrate Coase's belief that legal rules are justified only by reference to a cost-benefit analysis, and that nuisances that are often regarded as the fault of a party are more symmetrical conflicts between the interests of the two parties.

If there were no such things as the costs of making a transaction, legal rules would be irrelevant to the maximization of output.

Because in the real world there are costs of negotiation and information gathering, legal rules are justified to the extent of their ability to assign the most efficient bearer rights.

This article, together with the one entitled The nature of the company, led Coase to obtain the Nobel Prize in Economic Sciences in 1991.[1]​.

Coase argued that if we lived in a world without transaction costs, people would negotiate with each other to produce a more efficient distribution of resources, regardless of the initial allocation.

This is superior to allocation through litigation. Coase uses the example of a nuisance case called Sturgevs v Bridgman, where a confectioner and a doctor were neighbors who went to court to see which of the two would have to change residence.[2]​.

Coase states that regardless of whether the judge rules that the confectioner must stop generating noise, or that the doctor has to put up with the confectioner; "the parties could reach a mutually beneficial pact that reaches the same result of distribution of resources.").

However, many welfare maximizers are generally perceived reallocations for the transaction costs involved in the negotiation.

For example, the confectioner may have many neighbors who claim a "nuisance" - some legitimately and some not, and some of the neighbors who are bothered and have complained may choose to endure the inconvenience for excessive compensation. In these cases, private transaction costs can lead to a more efficient allocation of resources.

In cases like these, with potentially high transaction costs, the law should produce a result similar to what would be produced if transaction costs were eliminated. Therefore, courts must be guided by the most efficient solution.