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The Problem of Social Cost  R. H. Coase (1960) Mikhail Dubov
The problem to be examined <ul><li>Some production processes create negative externalities for other firms or individuals....
Reciprocal nature of the problem <ul><li>Standard analysis obscures the nature of choice to be made </li></ul><ul><ul><li>...
Objective <ul><li>The system should minimize the total (maximize total output) of all parties involved. </li></ul><ul><li>...
Liability for Damage <ul><li>Pollutant liable for damage </li></ul><ul><ul><li>Cattle-raiser can fence the property </li><...
Result <ul><li>There will always be room for bargaining unless the marginal gain of one party is equal to marginal loss of...
The Coase Theorem <ul><li>If the property rights are clearly defined then the agents can reach optimal allocation by free ...
Costs of Market Transactions <ul><li>Transaction costs may make the optimal allocation unattainable </li></ul><ul><li>Ther...
Critique of Pigou <ul><li>Failure to take into account costs imposed on pollutant </li></ul><ul><li>Tax equal to damage ca...
Change of Approach <ul><li>Take into account opportunity cost  as well as difference between private and social cost </li>...
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The problem of social cost

A presentation of an article by Ronald Coase

The problem of social cost

  1. 1. The Problem of Social Cost R. H. Coase (1960) Mikhail Dubov
  2. 2. The problem to be examined <ul><li>Some production processes create negative externalities for other firms or individuals. </li></ul><ul><ul><li>Confectioner and Doctor </li></ul></ul><ul><ul><li>Farmer and cattle-raiser </li></ul></ul><ul><li>Standard analysis follows Pigou </li></ul><ul><ul><li>Owners of the firms liable for the damage </li></ul></ul><ul><ul><li>Place a tax equivalent to the damage (Pigovian Tax) </li></ul></ul><ul><ul><li>Remove factory from the area (zoning) </li></ul></ul>
  3. 3. Reciprocal nature of the problem <ul><li>Standard analysis obscures the nature of choice to be made </li></ul><ul><ul><li>Pollutant harms others </li></ul></ul><ul><ul><li>Removing pollution will harms the pollutant </li></ul></ul><ul><ul><li>Opportunity cost is neglected </li></ul></ul><ul><li>Both parties can prevent the damage </li></ul><ul><ul><li>Doctor can move to another room </li></ul></ul><ul><ul><li>Confectioner can change his way of production or move </li></ul></ul>
  4. 4. Objective <ul><li>The system should minimize the total (maximize total output) of all parties involved. </li></ul><ul><li>This should lead to the same effect as internalizing the externality </li></ul><ul><ul><li>If doctor and confectioner are a single firm it will regard the total effect of any allocation </li></ul></ul><ul><li>Assumption: no transaction costs </li></ul>
  5. 5. Liability for Damage <ul><li>Pollutant liable for damage </li></ul><ul><ul><li>Cattle-raiser can fence the property </li></ul></ul><ul><ul><li>Decrease production (have smaller herd) </li></ul></ul><ul><ul><li>Pay the farmer not to cultivate the land </li></ul></ul><ul><li>Pollutant not liable for damage </li></ul><ul><ul><li>Farmer can fence his property </li></ul></ul><ul><ul><li>Farmer can leave the land </li></ul></ul><ul><ul><li>Farmer can pay cattle-raiser to decrease the number of sheep </li></ul></ul>
  6. 6. Result <ul><li>There will always be room for bargaining unless the marginal gain of one party is equal to marginal loss of the other </li></ul><ul><li>This result is the same as the aim set before </li></ul>
  7. 7. The Coase Theorem <ul><li>If the property rights are clearly defined then the agents can reach optimal allocation by free bargaining </li></ul><ul><ul><li>Final allocation will be independent from allocation of liability for pollution </li></ul></ul><ul><ul><li>Allocation will depend on relative prices </li></ul></ul><ul><ul><li>No intervention from the government is needed </li></ul></ul>
  8. 8. Costs of Market Transactions <ul><li>Transaction costs may make the optimal allocation unattainable </li></ul><ul><li>There are ways to minimize transactions </li></ul><ul><ul><li>Single ownership of property rights </li></ul></ul><ul><ul><li>Restrictive covenants </li></ul></ul><ul><li>Government intervention may be even more costly </li></ul>
  9. 9. Critique of Pigou <ul><li>Failure to take into account costs imposed on pollutant </li></ul><ul><li>Tax equal to damage caused leads to unduly high costs. </li></ul><ul><ul><li>Lack of perfect knowledge of individual preferences makes better system impossible </li></ul></ul><ul><li>Bad incentives created by taxation </li></ul><ul><ul><li>Too many people living in the vicinity of the factory and too low pollution </li></ul></ul>
  10. 10. Change of Approach <ul><li>Take into account opportunity cost as well as difference between private and social cost </li></ul><ul><li>Start analysis with the approximation of existing situation rather than think of universal cases </li></ul><ul><li>Think of factors of production as rights not physical entities </li></ul>

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