1. Maria Cristina Fenoglio
The problem of Social Cost Coase, Ronald H.(1960) The Journal of Law and Economics, 3 (October): 1-44
Maria Cristina Fenoglio
Ronald Coase, 1991 Nobel Laureate, Economics

2. The problem of social cost
“Actions of business firms which have harmful effects on others”
Usual economic analysis follows Pigou, bringing most economists to three alternatives:
Liability: The owner of the factory is liable for the damage caused
Taxation: The owner of the factory is taxed according to the monetary value of the damage caused
Exclusion: The factory is excluded from residential districts

3. The problem of social cost
Coase’s contention:
These alternatives are inappropriate, hence they lead to results not necessarily, or even usually, desirable
The problem has a “reciprocal” nature

4. Coase theorem
(so labeled later by George Stigler)
When trade in externalities is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights

5. The example of the straying cattle
Assuming that “the market works smoothly” = No transaction costs
First case: Liability for damages = 1$/ton
Second case: No liability for damages
Assumption: annual cost of fencing = 9$
Number in Herd
(Steers)
Annual crop loss (tons)
Crop loss per additional steer (tons) 1 2 3 6 4 10

6. The example of the straying cattle
Key concepts
Whitout transaction costs it is economically irrelevant who is assigned initial property rights: the cattle-raiser and the farmer will work out an agreement whether to restrict the cattle or not based on the economic efficiency of doing so
Initial property rights allocation will matter only in determining income distribution

7. Transaction costs into account
Initially property rights will have a non-trivial effect
The property of the rights should be assigned such as that the owner of the rights want to take the economically efficient action
The role of the Government as “super-firm”
Economists tend to over-estimate the advantages coming from governmental regulation

8. Coase’s critics on Pigou’s position
Pigou: when divergences between social and private net products arise, additional State action may be required and desirable
Government can internalize externalities correcting market failures
Coase: Pigou’s position is inadequate

9. The example of the Railway company
The “Pigovian” way
1 train
2 trains
Value of services
150
250
Costs
- 50
- 100
Crops destruction
- 60
120
Since it would be better if the second train were not run (fall in value ot total production)
Since it would not run if the railway should be made liable for damages
Liability for damages seems the right approach

10. The example of the Railway company
Coase’s way:
2 trains
Value of services
250
Costs
-100
Crop destructions
-120
Fall in value of crop production
-160
Increase of production elsewhere
+150
Overall, operating the railway will increase the value of total production by 20$
A situation in which there is “uncompensated damage” is not necessarily undesirable:
whether it is desirable or not depends on the particular circumstances

11. Conclusions Ronald Coase: what is needed is a change of approach
Taking into account “opportunity costs”
Starting the analysis with a situation approximating that which actually exists
Considering factors of production not as “physical entities” but as “rights”

12. Conclusions
“In devising and choosing bertween social arrangements we should have regard for the total effect”

13. Comments
In the last 40 years in many economies the field where legislation changed probably the most is the one dealing with “social costs” of firms externalities.

14. Comments In economies where:
Transaction costs are very high
The “value” attributed to issues such as health and environment is extremely high
Taking into account the “total effect” has led to an increase in those very measures criticized by Coase, that is:
Liability
Taxation
Exclusion