CHICAGO JOURNALS The Problem of social Cost Author(s):R H. Coase Source: Journal of Law and Economics, Vol 3(Oct, 1960), pp. 1-44 Published by: The University of Chicago Press StableUrl:http://www.jstor.org/stable/724810 Accessed:22/03/200905:41 Your use of the jStOR archive indicates your acceptance of jSTOR's Terms and Conditions of Use, available at http://www.jstor.org/page/info/about/policies/terms.jspJstOr'sTermsandConditionsofUseprovidesinpartthatunless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you ay use content in the JSTOR archive only for your personal, non-commercial use Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/action/showpublisher?publishercode=ucpress Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed of such transmission JStOR is a not-for-profit organization founded in 1995 to build trusted digital archives for scholarship. We work with the holarly community to preserve their work and the materials they rely upon, and to build a common research platform that promotes the discovery and use of these resources. For more information about JSTOR, please contact support@jstor. org The University of Chicago Press is collaborating with JSTOR to digitize, preserve and extend access to Journal of ittp://www.jstor.org
The Problem of Social Cost Author(s): R. H. Coase Source: Journal of Law and Economics, Vol. 3 (Oct., 1960), pp. 1-44 Published by: The University of Chicago Press Stable URL: http://www.jstor.org/stable/724810 Accessed: 22/03/2009 05:41 Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/action/showPublisher?publisherCode=ucpress. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is a not-for-profit organization founded in 1995 to build trusted digital archives for scholarship. We work with the scholarly community to preserve their work and the materials they rely upon, and to build a common research platform that promotes the discovery and use of these resources. For more information about JSTOR, please contact support@jstor.org. The University of Chicago Press is collaborating with JSTOR to digitize, preserve and extend access to Journal of Law and Economics. http://www.jstor.org
h e durna LAW O ECONOMICS ⅴ OLUME I OCTOBER 1960 THE PROBLEM OF SOCIAL COST R. H. COASE I. THE PROBLEM To bE ExAMINED1 HIs 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 far ory, in which economists have largely followed the treatment of Pigou in The Economics of Welfare. The conclusions to which this kind of analy is 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 pro- duced and equivalent in money terms to the damage it would cause, or finally, to exclude the factory from residential districts (and presumably from other 1 This article, although concerned with a technical problem of economic analysis, arose ut of the study of the Political Economy of Broadcasting which I am he argument of the present article was implicit in a previous article roblem of allocating radio and television frequencies (The Federal Communication ommission, 2 J. Law& Econ. [1959])but comments which I have received seemed to uggest that it would be desirable to deal with the question in without reference to the original problem for the solution of which the analysis was de-
The Journal of LAW c ECONOMICS VOLUME III OCTOBER 1960 THE PROBLEM OF SOCIAL COST R. H. COASE University of Virginia I. THE PROBLEM TO BE EXAMINED1 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 fartory, in which economists have largely followed the treatment of Pigou in The Economics of Welfare. The conclusions to which this kind of analy?is 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 1 This article, although concerned with a technical problem of economic analysis, arose out of the study of the Political Economy of Broadcasting which I am now conducting. The argument of the present article was implicit in a previous article dealing with the problem of allocating radio and television frequencies (The Federal Communications Commission, 2 J. Law & Econ. [1959]) but comments which I have received seemed to suggest that it would be desirable to deal with the question in a more explicit way and without reference to the original problem for the solution of which the analysis was developed
THE JOURNAL OF LAW AND ECONOMICS 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 I. 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 article2 the case of a confectioner the noise and vibrations from whose ma chinery disturbed a doctor in his work. To avoid harming the doctor would inflict harm on the confectioner. The problem posed by this case was essential- ly whether it was worth while, as a result of restricting the methods of produc tion which could be used by the confectioner to secure more doctoring at the cost of a reduced supply of confectionery products. Another example is forded by the problem of straying cattle which destroy crops on neighbour ing land. If it is inevitable that some cattle will stray, an increase in the sup ply 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. assume that the harmful effect of the pollution is that it kills the question to be decided is: is the value of the fish lost greater or less 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 marg III. THE PRICING SYSTEM WITH LIABILITY FOR DAMAGE i propose to start my analysis by examining a case in which most econo mists would presumably agree that the problem would be solved in a com pletely satisfactory manner: when the damaging business has to pay for all damage caused and the pricing system works smoothly(strictly this means hat 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 a cattle-raiser are operating on neighbouring proper 2 Coase, The Federal Communications Commission, 2 J. Law Econ 26-27(1959) G.J. Stigler, The Theory of Price 105 (1952)
2 THE JOURNAL OF LAW AND ECONOMICS 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 article2 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, an 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.3 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 completely 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 a cattle-raiser are operating on neighbouring proper- 2 Coase, The Federal Communications Commission, 2 J. Law & Econ. 26-27 (1959). 3 G. J. Stigler, The Theory of Price 105 (1952)
THE PROBLEM OF SOCIAL COST ties. 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 farmers 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 farmers property is $9 and that the price of the crop is $1 per ton i assume that the relation between the number of cattle in the herd and the annual crop loss is as follows Number in Herd Annual Crop Loss Crop Loss per Additional 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 ther 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 lue 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 ame 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
THE PROBLEM OF SOCIAL COST 3 ties. 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 that 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 in Herd Annual Crop Loss Crop Loss per Additional (Steers) (Tons) Steer (Tons) 1 1 1 2 3 2 3 6 3 4 ! 0 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
THE JOURNAL OF LAW AND ECONOMICS 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 Of if cattI aising 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 I have said that the occupation of a neighbouring property by a cattle wiser would not cause the amount of production, or perhaps more exactly the amount of planting, by the farmer to increase. In fact, if the cattle-raising has any effect, it will be to decrease the amount of planting. The reason for this is that, for any given tract of land, if the value of the crop damaged is so great that the receipts from the sale of the undamaged crop are less than the total costs of cultivating that tract of land, it will be profitable for the farmer and the cattle-raiser to make a bargain whereby that tract of land is left un cultivated. This can be made clear by means of an arithmetical example Assume initially that the value of the crop obtained from cultivating a given tract of land is $12 and that the cost incurred in cultivating this tract of land is $10, the net gain from cultivating the land being $2. I assume for purposes of simplicity that the farmer owns the land. Now assume that the cattle- raiser starts operations on the neighbouring property and that the value of the crops damaged is $1. In this case $11 is obtained by the farmer from sale on he market and $1 is obtained from the cattle-raiser for damage suffered and the net gain remains $2. Now suppose that the cattle-raiser finds it profitable to increase the size of his herd, even though the amount of damage rises to $3 which means that the value of the additional meat production is greater than the additional costs, including the additional $2 payment for damage. But the total payment for damage is now $3. The net gain to the farmer from cultivat ing the land is still $2. The cattle-raiser would be better off if the farmer would agree not to cultivate his land for any payment less than $3. The farmer would be agreeable to not cultivating the land for any payment greater than $2. There is clearly room for a mutually satisfactory bargain which would lead to the abandonment of cultivation But the same argument applies not only to the whole tract cultivated by the farmer but also to any d on the assumption that the alternative to cultivation of the crop is abandonment of cultivation altogether. But this need not be so There may be crops which are less liable to damage by cattle but which would not profitable as the crop grown in the absence of damage. Thus, if the cultivation of a new r of $1 instead of $2, and the size of the herd whicl with the old crop would cause $1 damage with the new crop, it ould be profitable to the cattle-raiser to pay any sum less than $2 to induce the farmer
4 THE JOURNAL OF LAW AND ECONOMICS 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 cattleraiser would pay the market price for any crop damaged. Of course, if cattleraising 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. I have said that the occupation of a neighbouring property by a cattleraiser would not cause the amount of production, or perhaps more exactly the amount of planting, by the farmer to increase. In fact, if the cattle-raising has any effect, it will be to decrease the amount of planting. The reason for this is that, for any given tract of land, if the value of the crop damaged is so great that the receipts from the sale of the undamaged crop are less than the total costs of cultivating that tract of land, it will be profitable for the farmer and the cattle-raiser to make a bargain whereby that tract of land is left uncultivated. This can be made clear by means of an arithmetical example. Assume initially that the value of the crop obtained from cultivating a given tract of land is $12 and that the cost incurred in cultivating this tract of land is $10, the net gain from cultivating the land being $2. I assume for purposes of simplicity that the farmer owns the land. Now assume that the cattleraiser starts operations on the neighbouring property and that the value of the crops damaged is $1. In this case $11 is obtained by the farmer from sale on the market and $1 is obtained from the cattle-raiser for damage suffered and the net gain remains $2. Now suppose that the cattle-raiser finds it profitable to increase the size of his herd, even though the amount of damage rises to $3; which means that the value of the additional meat production is greater than the additional costs, including the additional $2 payment for damage. But the total payment for damage is now $3. The net gain to the farmer from cultivating the land is still $2. The cattle-raiser would be better off if the farmer would agree not to cultivate his land for any payment less than $3. The farmer would be agreeable to not cultivating the land for any payment greater than $2. There is clearly room for a mutually satisfactory bargain which would lead to the abandonment of cultivation.4 But the same argument applies not only to the whole tract cultivated by the farmer but also to any 'The argument in the text has proceeded on the assumption that the alternative to cultivation of the crop is abandonment of cultivation altogether. But this need not be so. There may be crops which are less liable to damage by cattle but which would not be as profitable as the crop grown in the absence of damage. Thus, if the cultivation of a new crop would yield a return to the farmer of $1 instead of $2, and the size of the herd which would cause $3 damage with the old crop would cause $1 damage with the new crop, it would be profitable to the cattle-raiser to pay any sum less than $2 to induce the farmer