History of Economic Thought II - Neoclassical economics of the first half of the Twentieth Century was focused on developing increasingly sophisticated models of equilibria. As we saw in "Competition, Part 1," in equilibrium there's no role for entrepreneurship; but there's also no obvious role institutions, the "rules of the game," since by assumption the game has been completed, and no role for failures to satisfy the marginal conditions on all margins. In the lecture, economist Charles N. Steele explains how A.C. Pigou developed the theory of externality and market failure. Steele then introduces Ronald Coase and his theory of transaction cost. Transaction cost theory upends the neoclassical theory of externality, because in the neoclassical world of costless transacting, externalities should not exist.

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