The Problem of Social Cost
Encyclopedia
'The Problem of Social Cost' (1960) by Ronald Coase
is an article dealing with economic problem of externalities. It draws from a number of English legal cases and statutes to illustrate Coase's belief that legal rules are only justified by reference to a cost benefit analysis, and that nuisances that are often regarded as being the fault of one party are more symmetric conflicts between the interests of the two parties. If there were no such things as the costs of doing a transaction, legal rules would be irrelevant to the maximization of production. Because in the real world there are costs of bargaining and information gathering, legal rules are justified to the extent of their ability to allocate rights to the most efficient right-bearer. Along with an earlier article, The Nature of the Firm
, this was cited as being a reason for Coase's award of the Nobel Memorial Prize in Economic Sciences
in 1991.
case named Sturges v Bridgman
, where a noisy sweetmaker and a quiet doctor were neighbours and went to court to see who should have to move. Coase said that regardless of whether the judge ruled that the sweetmaker had to stop using his machinery, or that the doctor had to put up with it, they could strike a mutually beneficial bargain
about who moves house that reaches the same outcome of resource distribution.
However, many welfare-maximizing reallocations are often forgone because of the transaction costs involved in bargaining . For instance, the sweetmaker may have many neighbors who claim "nuisance" — some legitimate and some not, that the firm would have to sort through, and some of those neighbors who do claim nuisance may try to hold out for excessive compensation. In these cases, the transaction costs eat away, and ultimately eclipse, the price signals that would have led to the most efficient distribution of resources.
In cases like these with potentially high transaction costs, the law ought to produce an outcome similar to what would result if the transaction costs were eliminated. Hence courts should be guided by the most efficient
solution.
The ultimate thesis is that law and regulation are not as important or effective at helping people as lawyers and government planners believe. Coase and others like him wanted a change of approach, to put the burden of proof for positive effects on a government that was intervening in the market, by analysing the costs of action .
The argument forms the basis of the Coase Theorem
as labeled by George Stigler.
In the real world where people cannot negotiate costlessly, there may be collective action problems of those caused a nuisance, for instance by smoke emissions from a factory to many neighbouring farms, and so getting together to negotiate effectively can be difficult against a single polluter because of coordination problems. If it is efficient for the farmers to pay the factory to abate the emissions, some of those the farmers may hold off paying their fair share, hoping to get a free ride. The factory may be in a better position to know what measures to take to reduce harm, and can be the cheapest avoider, illustrating Coase's argument.
and the third is the Railway (Fires) Act 1905. Apart from these main examples, the following cases are referred to.
Ronald Coase
Ronald Harry Coase is a British-born, American-based economist and the Clifton R. Musser Professor Emeritus of Economics at the University of Chicago Law School. After studying with the University of London External Programme in 1927–29, Coase entered the London School of Economics, where he took...
is an article dealing with economic problem of externalities. It draws from a number of English legal cases and statutes to illustrate Coase's belief that legal rules are only justified by reference to a cost benefit analysis, and that nuisances that are often regarded as being the fault of one party are more symmetric conflicts between the interests of the two parties. If there were no such things as the costs of doing a transaction, legal rules would be irrelevant to the maximization of production. Because in the real world there are costs of bargaining and information gathering, legal rules are justified to the extent of their ability to allocate rights to the most efficient right-bearer. Along with an earlier article, The Nature of the Firm
The Nature of the Firm
The Nature of the Firm 4 Economica 386–405, is an influential article by Ronald Coase. It offered an economic explanation of why individuals choose to form partnerships, companies and other business entities rather than trading bilaterally through contracts on a market.-Summary:Given that...
, this was cited as being a reason for Coase's award of the Nobel Memorial Prize in Economic Sciences
Nobel Memorial Prize in Economic Sciences
The Nobel Memorial Prize in Economic Sciences, commonly referred to as the Nobel Prize in Economics, but officially the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel , is an award for outstanding contributions to the field of economics, generally regarded as one of the...
in 1991.
Summary
Coase argued that if we lived in a world without transaction costs, people would bargain with one another to produce the most efficient distribution of resources, regardless of the initial allocation. This is superior to allocation through litigation . Coase used the example of a nuisanceNuisance
Nuisance is a common law tort. It means that which causes offence, annoyance, trouble or injury. A nuisance can be either public or private. A public nuisance was defined by English scholar Sir J. F...
case named Sturges v Bridgman
Sturges v Bridgman
Sturges v Bridgman LR 11 Ch D 852 is a landmark case in nuisance. It decides that what constitutes reasonable use of one's property depends on the character of the locality...
, where a noisy sweetmaker and a quiet doctor were neighbours and went to court to see who should have to move. Coase said that regardless of whether the judge ruled that the sweetmaker had to stop using his machinery, or that the doctor had to put up with it, they could strike a mutually beneficial bargain
Bargain
Bargain could mean some of the following:* The process whereby buyer and seller agree the price of goods or services. See bargaining.* An agreement to exchange goods at a price.* Such an agreement where one of the parties thinks the price is very favourable....
about who moves house that reaches the same outcome of resource distribution.
However, many welfare-maximizing reallocations are often forgone because of the transaction costs involved in bargaining . For instance, the sweetmaker may have many neighbors who claim "nuisance" — some legitimate and some not, that the firm would have to sort through, and some of those neighbors who do claim nuisance may try to hold out for excessive compensation. In these cases, the transaction costs eat away, and ultimately eclipse, the price signals that would have led to the most efficient distribution of resources.
In cases like these with potentially high transaction costs, the law ought to produce an outcome similar to what would result if the transaction costs were eliminated. Hence courts should be guided by the most efficient
Efficiency (economics)
In economics, the term economic efficiency refers to the use of resources so as to maximize the production of goods and services. An economic system is said to be more efficient than another if it can provide more goods and services for society without using more resources...
solution.
The ultimate thesis is that law and regulation are not as important or effective at helping people as lawyers and government planners believe. Coase and others like him wanted a change of approach, to put the burden of proof for positive effects on a government that was intervening in the market, by analysing the costs of action .
The argument forms the basis of the Coase Theorem
Coase theorem
In law and economics, the Coase theorem , attributed to Ronald Coase, describes the economic efficiency of an economic allocation or outcome in the presence of externalities. The theorem states that if trade in an externality is possible and there are no transaction costs, bargaining will lead to...
as labeled by George Stigler.
Theoretical challenges
Guido Calabresi in his book The Cost of Accidents (1970) argues that it is still efficient to hold companies liable who produce greater wealth.In the real world where people cannot negotiate costlessly, there may be collective action problems of those caused a nuisance, for instance by smoke emissions from a factory to many neighbouring farms, and so getting together to negotiate effectively can be difficult against a single polluter because of coordination problems. If it is efficient for the farmers to pay the factory to abate the emissions, some of those the farmers may hold off paying their fair share, hoping to get a free ride. The factory may be in a better position to know what measures to take to reduce harm, and can be the cheapest avoider, illustrating Coase's argument.
Cases and statutes
Coase uses three main examples in his article to attempt to illustrate his points. The first is a fictional cattle herder and a farmer, but the second is the case Sturges v BridgmanSturges v Bridgman
Sturges v Bridgman LR 11 Ch D 852 is a landmark case in nuisance. It decides that what constitutes reasonable use of one's property depends on the character of the locality...
and the third is the Railway (Fires) Act 1905. Apart from these main examples, the following cases are referred to.
- Fontainebleu Hotel Corp. v. Forty-Five Twenty-Five, Inc., 114 So. 2d 357 (1959)
- Cooke v Forbes (1867-1868) LR 5 Eq 166
- Bryant v Lefever (1878-1879) 4 CPD 172, Bramwell LJ and Cotton LJ
- Bass v Gregory (1890) 25 QBD 481
- Attorney General v Doughty (1752) 28 ER 290
- Versailles Borough v. McKeesport Coal & Coke Co. (1935) 83 Pitts. Leg. J 379, 385
- Webb v Bird (1863) 143 ER 332
- Rushmer v Polsue and Alfieri, Ltd (1906) 1 Ch 234
- Adams v Ursell (1913) 1 Ch 269, regarding fish and chipsFish and chipsFish and chips is a popular take-away food in the United Kingdom, Australia, New Zealand and Canada...
- Andreae v Selfridge and Company Ltd (1938) 1 Ch 1
- Delta Air Corporation v. Kersey (1942) 193 Ga. 862
- Thrasher v. City of Atlanta (1934) 178 Ga. 514
- Georgia Railroad and Banking Co. v. Maddox (1902) 116 Ga. 64
- Smith v. New England Aircraft Co. (1930) 270 Mass. 511
- Vaughan v Taff Vale Railway Co. (1858) 3 H and N 743
- Boulston v Hardy (1597) 77 ER 216
- Stearn v Prentice Bros Ltd (1919) 1 KB 395
- Bland v Yates (1913-1914) 58 Sol J 612