The Problem of Social Cost

"The Problem of Social Cost" is an article published by Ronald Coase in 1960 in the "Journal of Law and Economics" about 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. If there were no such things as the costs of doing a transaction, legal rules would be irrelevant to the maximisation of production. But because in the real world there are costs of bargaining and information gathering, legal rules are justified by, and if they do in use, their ability to allocate rights to the most efficient right-bearer. Along with another earlier article, "The Nature of the Firm", this was cited as being a reason for Coase's award of the Bank of Sweden Prize (or the Nobel Memorial Prize) for Economics in 1991.


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, "The Problem of Social Coast", 1–44] Coase used the example of a nuisance 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. ["Sturges v. Bridgman" (1879) 11 Ch D 852] 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. [Coase, "The Problem of Social Cost", IV, 7] 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, "The Problem of Social Cost", V, 9] 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. [Coase, "The Problem of Social Cost", VIII, 23]

The argument forms the basis of the Coase Theorem as labeled by George Stigler.

Theoretical challenges

Guido Calabresi in his book "The Cost of Accidents" (1970) ["The Cost of Accidents" (1970) , 135-403] argues that it is still efficient to hold companies liable who produce greater wealth. [see also, Calabresi, "Transaction Costs, Resource Allocation and Liability Rules, A Comment' (1968) Journal of Law and Economics 11, 67, 71-3]

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 bargaining power imbalances. Also, some of those the farmers may hold off paying their fair share of the money, to get a free ride. Also, the factory may be in a better position to know what measures to take to reduce harm, and can be seen as the cheapest cost avoider.

ee also

*"The Nature of the Firm"



*cite journal |quotes= |last=Coase |first=Ronald H.|authorlink=Ronald H. Coase |year=1937|month=November |title=The Nature of the Firm |journal=Economica |volume=4 |issue=16 |pages=386–405 |id= |url= |accessdate=2007-02-10 |doi=10.1111/j.1468-0335.1937.tb00002.x
*cite journal |quotes= |last=Coase |first=Ronald H.|authorlink=Ronald H. Coase |year=1960|month=October |title=The Problem of Social Cost (this online version excludes some parts) |journal=Journal of Law and Economics |volume=3 |issue= |pages=1–44 |id= |url= "The Problem of Social Cost |accessdate=2007-02-10

External links

* [ Nobel prize in Economics 1991 - Press release]

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