The Problem of Social Cost
RONALD COASE Ronald Coase is Professor Emeritus at University of Chicago Law School and a Nobel Laureate in Economics. This article is from The Journal of Law and Economics (October 1960). Several passages devoted to extended discussions of legal decisions have been omitted. I. THE PROBLEM TO BE EXAMINED This paper is concerned with those actions of business ﬁrms which have harmful 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 liable 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 1
COASE: The Problem of Social Cost 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 suppose that a farmer and cattle-raiser are...
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