The Problem of Social Cost

The Problem of Social Cost

RONALD COASE
I. THE PROBLEM TO BE EXAMINED
This paper is concerned with those actions of business firms which have harm-
ful effects on others. The standard example is that of a factory the smoke
from which has harmful effects on those occupying neighbouring properties.
The economic analysis of such a situation has usually proceeded in terms of
a divergence between the private and social product of the factory, in which
economists have largely followed the treatment of Pigou in The Economies of
Welfare. The conclusion to which this kind of analysis seems to have led most
economists is that it would be desirable to make the owner of the factory li-
able for the damage caused to those injured by the smoke, or alternatively, to
place a tax on the factory owner varying with the amount of smoke produced
and equivalent in money terms to the damage it would cause, or finally, to
exclude the factory from residential districts (and presumably from other areas
in which the emission of smoke would have harmful effects on others). It is my
contention that the suggested courses of action are inappropriate, in that they
lead to results which are not necessarily, or even usually, desirable.
II. THE RECIPROCAL NATURE OF THE PROBLEM
The traditional approach has tended to obscure the nature of the choice that
has to be made. The question is commonly thought of as one in which A
inflicts harm on B and what has to be decided is: how should we restrain A?
But this is wrong. We are dealing with a problem of a reciprocal nature. To
avoid the harm to, B would inflict harm on A. The real question that has to
be decided is: should A be allowed to harm B or should B be allowed to harm
A? The problem is to avoid the more serious harm. I instanced in my previous
article the case of a confectioner the noise and vibrations from whose machinery
disturbed a doctor in his work. To avoid harming the doctor would inflict harm
on the confectioner. The problem posed by this case was essentially whether
it was worth while, as a result of restricting the methods of production which
could be used by the confectioner, to secure more doctoring at the cost of a
reduced supply of confectionery products. Another example is afforded by the
problem of straying cattle which destroy crops on neighbouring land. If it is
inevitable that some cattle will stray, all increase in the supply of meat can only
be obtained at the expense of a decrease in the supply of crops. The nature of
the choice is clear: meat or crops. What answer should be given is, of course,
not clear unless we know the value of what is obtained as well as the value of
what is sacrificed to obtain it. To give another example, Professor George J.
Stigler instances the contamination of a stream. If we assume that the harmful
effect of the pollution is that it kills the fish, the question to be decided is: is
the value of the fish lost greater or less than the value of the product which
the contamination of the stream makes possible. It goes almost without saying
that this problem has to be looked at in total and at the margin.
III. THE PRICING SYSTEM WITH LIABILITY FOR DAMAGE
I propose to start my analysis by examining a case in which most economists
would presumably agree that the problem would be solved in a compeletely
satisfactory manner: when the damaging business has to pay for all damage
caused and the pricing system works smoothly (strictly this means that the
operation of a pricing system is without cost).
A good example of the problem under discussion is afforded by the case of
straying cattle which destroy crops growing on neighbouring land. Let us sup-
pose that a farmer and cattle-raiser are operating on neighbouring properties.
Let us further suppose that, without any fencing between the properties, an
increase in the size of the cattle-raiser’s herd increases the total damage to the
farmer’s crops. What happens to the marginal damage as the size of the herd
increases is another matter. This depends on whether the cattle tend to follow
one another or to roam side by side, on whether they tend to be more or less
restless as the size of the herd increases and on other similar factors. For my
immediate purpose, it is immaterial what assumption is made about marginal
damage as the size of the herd increases.
To simplify the argument, I propose to use an arithmetical example. I
shall assume that the annual cost of fencing the farmer’s property is $9 and the
price of the crop is $1 per ton. Also, I assume that the relation between the
number of cattle in the herd and the annual crop loss is as follows:

Number Annual Crop Loss Crop Loss Per
In Herd (Steers) (Tons) Additional Steer (tons)

1 1 1
2 3 2
3 6 3
4 10 4

Given that the cattle-raiser is liable for the damage caused, the additional
annual cost imposed on the cattle-raiser if he increased his herd from, say, 2
to 3 steers is $3 and in deciding on the size of the herd, he will take this into
account along with his other costs. That is, he will not increase the size of
the herd unless the value of the additional meat produced (assuming that the
cattle-raiser slaughters the cattle) is greater than the additional costs that this
will entail, including the value of the additional crops destroyed. Of course,
if, by the employment of dogs, herdsmen, aeroplanes, mobile radio and other
means, the amount of damage can be reduced, these means will be adopted
when their cost is less than the value of the crop which they prevent being lost.
Given that the annual cost of fencing is $9, the cattle-raiser who wished to have
a herd with 4 steers or more would pay for fencing to be erected and maintained,
assuming that other means of attaining the same end would not do so more
cheaply. When the fence is erected, the marginal cost due to the liability for
damage becomes zero, except to the extent that an increase in the size of the
herd necessitates a stronger and therefore more expensive fence because more
steers are liable to lean against it at the same time. But, of course, it may be
cheaper for the cattle-raiser not to fence and to pay for the damaged crops, as
in my arithmetical example, with 3 or fewer steers.
It might be thought that the fact that the cattle-raiser would pay for all
crops damaged would lead the farmer to increase his planting if a cattle-raiser
came to occupy the neighbouring property. But this is not so. If the crop was
previously sold in conditions of perfect competition, marginal cost was equal
to price for the amount of planting undertaken and any expansion would have
reduced the profits of the farmer. In the new situation, the existence of crop
damage would mean that the farmer would sell less on the open market but his
receipts for a given production would remain the same, since the cattle-raiser
would pay the market price for any crop damaged. Of course, if cattle-raising
commonly involved the destruction of crops, the coming into existence of a
cattle-raising industry might raise the price of the crops involved and farmers
would then extend their planting. But I wish to confine my attention to the
individual farmer.

Conclusion

Notes

See Also

References and Further Reading

About the Author/s and Reviewer/s

Author: international

Mentioned in these Entries

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