| Number in Herd (Steers) | Annual Crop Loss (Tons) | Crop Loss per Additional Steer (Tons) |
| 1 | 1 | 1 |
| 2 | 3 | 2 |
| 3 | 6 | 3 |
| 4 | 10 | 4 |
(Would build fence if herd > 3.)
3: 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
were to occupy the neighboring property. But this is not so. (focus on P=MC).
3. 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. (considers a tract with $2 profit and $3 loss from cattle).
4n: 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 to change his crop (since this would reduce damage liability from $3 to
$1) and it would be profitable for the farmer to do so if the amount received was more
than, $1 (the reduction in his return caused by switching crops). In fact, there would be
room for a mutually satisfactory bargain in all cases in which a change of crop would
reduce the amount of damage by more than it reduces the value of the crop (excluding
damage)-in all cases, that is, in which a change in the crop cultivated would lead to an
increase in the value of production.
5. What needs to be emphasized is that the fall in the value of
production elsewhere which would be taken into account in the costs of the cattle-raiser
may well be less than the damage which the cattle would cause to the crops in the ordinary
course of events. This is because it is possible, as a result of market transactions, to
discontinue cultivation of the land. This is desirable in all cases in which the damage
that the cattle would cause, and for which the cattle-raiser would be willing to pay,
exceeds the amount which the farmer would pay for the use of land.
5: I now turn to the case in which, although the pricing system is
assumed to work smoothly (that is, costlessly), the damaging business is not liable for
any of the damage which it causes. This business does not have to make a payment to those
damaged by its actions. I propose to show that the allocation of resources will be the
same in this case as it was when the damaging business was liable for damage caused.
6: The cattle-raiser would therefore receive $3 from the farmer if he
kept two steers instead of three. This $3 foregone is therefore part of the cost incurred
in keeping the third steer. Whether the $3 is a payment which the cattle-raiser has to
make if he adds the third steer to his herd (which it would be if the cattle-raiser was
liable to the farmer for damage caused to the crop) or whether it is a sum of money which
he would have received if he did not keep a third steer (which it would be if the
cattle-raiser was not liable to the farmer for damage caused to the crop) does not affect
the final result. In both cases $3 is part of the cost of adding a third steer, to be
included along with the other costs. If the increase in the value of production in
cattle-raising through increasing the size of the herd from two to three is greater than
the additional costs that have to be incurred (including the $3 damage to crops), the size
of the herd will be increased. Otherwise, it will not.
7: It is necessary to know whether the damaging business is liable or
not for damage caused since without the establishment of this initial delimitation of
rights there can be no market transactions to transfer and recombine them. But the
ultimate result (which maximizes the value of production) is independent of the legal
position if the pricing system is assumed to work without cost.
7: The argument has proceeded up to this point on the assumption that
there were no costs involved in carrying out market transactions. This is, of course, a
very unrealistic assumption. In order to carry out a market transaction it is necessary to
discover who it is that one wishes to deal with, to inform people that one wishes to deal
and on what terms, to conduct negotiations leading up to a bargain, to draw up the
contract, to undertake the inspection needed to make sure that the terms of the contract
are being observed, and so on. These operations are often extremely costly, sufficiently
costly at any rate to prevent many transactions that would be carried out in a world in
which the pricing system worked without cost.
8: In these conditions the initial delimitation of legal rights does
have an effect on the efficiency with which the economic system operates. One arrangement
of rights may bring about a greater value of production than any other. But unless this is
the arrangement of rights established by the legal system, the costs of reaching the same
result by altering and combining rights through the market may be so great that this
optimal arrangement of rights, and the greater value of production which it would bring,
may never be achieved.
8: It is clear that an alternative form of economic organization which
could achieve the same result at less cost than would be incurred by using the market
would enable the value of production to be raised. As I explained many years ago, the firm
represents such an alternative to organizing production through market transactions.
Within the firm individual bargains between the various cooperating factors of production
are eliminated and for a market transaction is substituted an administrative decision.
9: An alternative solution is direct government regulation. Instead of
instituting a legal system of rights which can be modified by transactions on the market,
the government may impose regulations which state what people must or must not do and
which have to be obeyed.
9: But the governmental administrative machine is not itself costless.
It can, in fact, on occasion be extremely costly. Furthermore, there is no reason to
suppose that the restrictive and zoning regulations, made by a fallible administration
subject to political pressures and operating without any competitive check, will
necessarily always be those which increase the efficiency with which the economic system
operates.
10: There is, of course, a further alternative, which is to do nothing
about the problem at all. And given that the costs involved in solving the problem by
regulations issued by the governmental administrative machine will often be heavy
(particularly if the costs are interpreted to include all the consequences which follow
from the government engaging in this kind of activity), it will no doubt be commonly the
case that the gain which would come from regulating the actions which give rise to the
harmful effects will be less than the costs involved in government regulation.
10: It is my belief that economists, and policy-makers generally, have
tended to over-estimate the advantages, which come from governmental regulation. But this
belief, even if justified, does not do more than suggest that government regulation should
be curtailed. It does not tell us where the boundary line should be drawn.
10: Of course, if market transactions were costless, all that matters
(questions of equity apart) is that the rights of the various parties should be
well-defined and the results of legal actions easy to forecast. But as we have seen, the
situation is quite different when market transactions are so costly as to make it
difficult to change the arrangement of rights established by the law. In such cases, the
courts directly influence economic activity. It would therefore seem desirable that the
courts should understand the economic consequences of their decisions and should, insofar
as this is possible without creating too much uncertainty about the legal position itself,
take these consequences into account when making their decisions. Even when it is possible
to change the legal delimitation of rights through market transactions, it is obviously
desirable to reduce the need for such transactions and thus reduce the employment of
resources in carrying them out.
11: to quote Posser on Torts, a person may make use of his own property
or . . . conduct his own affairs at the expense of some harm to his neighbors. He may
operate a factory whose noise and smoke cause some discomfort to others, so long as he
keeps within reasonable bounds. It is only when his conduct is unreasonable, in the
light of its utility and the harm which results [italics added], that it becomes a
nuisance .
11: The problem which we face in dealing with actions which have
harmful effects is not simply one of restraining those responsible for them. What has to
be decided is whether the gain from preventing the harm is greater than the loss which
would be suffered elsewhere as a result of stopping the action which produces the harm.
100: Smith v. New England Aircraft Co. (270 Mass. 511, 523, 170 N.E.
385, 390 (1930): "There are...analogies where the invasion of the airspace over
underlying land by noise, smoke, vibration, dust and disagreeable odors, having been
authorized by the legislative department of government and not being in effect a
condemnation of the property although in some measure depreciating its market value, must
be borne by the land owner without compensation or remedy."
101: "While statutory enactments add to the list of nuisances,
action is also taken to legalize what would otherwise be nuisances under the common law.
The kind of situation which economists are prone to consider as requiring Government
action is, in fact, often the result of Government action. Such action is not necessarily
unwise. But there is a real danger that extensive government intervention in the economic
system may lead to the protection of those responsible for harmful effects being carried
too far."
12: "Pigou goes on to say that if self-interest does promote
economic welfare, it is because human institutions have been devised to make it so."
13: Pigou's example: It might happen . . . that costs are thrown upon
people not directly concerned, through, say, uncompensated damage done to surrounding
woods by sparks from railway engines. All such effects must be included-some of them will
be positive, others negative elements-in reckoning up the social net product of the
marginal increment of any volume of resources turned into any use or place.
13: The example used by Pigou refers to a real situation. In Britain, a
railway does not normally have to compensate those who suffer damage by fire caused by
sparks from an engine.
13: Halsbury's Laws of England: “If railway undertakers use steam
engines on their railway without express statutory authority to do so, they are liable,
irrespective of any negligence on their part, for fires caused by sparks from engines.
Railway undertakers are, however, generally given statutory authority to use steam engines
on their railway; accordingly, if an engine is constructed with the precautions which
science suggests against fire and is used without negligence, they are not responsible at
common law for any damage which may be done by . sparks. . . . In the construction of an
engine the undertaker is bound to use all the discoveries which science has put within its
reach in order to avoid doing harm, provided they are such as it is reasonable to require
the company to adopt, having proper regard to the likelihood of the damage and to the cost
and convenience of the remedy; but it is not negligence on the part of an undertaker if it
refuses to use an apparatus the efficiency of which is open to bona fide doubt. To this
general rule, there is a statutory exception arising from the Railway (Fires) Act, 1905,
as amended in 1923. This concerns agricultural land or agricultural crops.”
14: If we treat Pigou's example as referring to the position before
1905, or as being an arbitrary example (in that he might just as well have written
"surrounding buildings" instead of "surrounding woods"), then it is
clear that the reason why compensation was not paid must have been that the railway had
statutory authority to run steam engines (which relieved it of liability for fires caused
by sparks). That this was the legal position was established in 1860, in a case, oddly
enough, which concerned the burning of surrounding woods by a railway, and thelaw on this
point has not been changed (apart from the one exception) by a century of railway
legislation, including nationalization.
14: In the real world, Pigou's example could only exist as a result of
a deliberate choice of the legislature.... The only circumstances in which compensation
would not be paid would be those in which there had been government action. It is strange
that Pigou, who clearly thought it desirable that compensation should be paid, should
leave chosen this particular example to demonstrate how it is possible "for State
action to improve upon `natural' tendencies."
15: Consider a railway, which is not liable for damage by fires caused
by sparks from its engines, which runs two trains per day on a certain line. Suppose that
running one train per day would enable the railway to perform services worth $150 per
annum and running two trains a day would enable the railway to perform services worth $250
per annum. Suppose further that the cost of running one train is $50 per annum and two
trains $100 per annum. Assuming perfect competition, the cost equals the fall in the value
of production elsewhere due to the employment of additional factors of production by the
railway. Clearly the railway would find it profitable to run two trains per day.
15: But suppose that running one train per day would destroy by fire
crops worth (on an average over the year) $60 and two trains a day would result in the
destruction of crops worth $120. In these circumstances running one train per day would
raise the value of total production but the running of a second train would reduce the
value of total production. The second train would enable additional railway services worth
$100 per annum to be performed. But the fall in the value of production elsewhere would be
$110 per annum; $50 as a result of the employment of additional factors of production and
$60 as a result of the destruction of crops. Since it would be better if the second train
were not run and since it would not run if the railway were liable for damage caused to
crops, the conclusion that the railway should be made liable for the damage seems
irresistible. Undoubtedly it is this kind of reasoning which underlies the Pigovian
position.
15: The conclusion that it would be better if the second train did not
run is correct. The conclusion that it is desirable that the railway should be made liable
for the damage it causes is wrong. Let us change our assumption concerning the rule of
liability. Suppose that the railway is liable for damage from fires caused by sparks from
the engine. A farmer on lands adjoining the railway is then in the position that, if his
crop is destroyed by fires caused by the railway, he will receive the market price from
the railway; but if his crop is not damaged, he will receive the market price by sale. It
therefore becomes a matter of indifference to him whether his crop is damaged by fire or
not. The position is very different when the railway is not liable. Any crop destruction
through railway-caused fires would then reduce the receipts of the farmer. He would
therefore take out of cultivation any land for which the damage is likely to be greater
than the net return of the land (for reasons explained at length in Section III). A change
from a regime in which the railway is not liable for damage to one in which it is liable
is likely therefore to lead to an increase in the amount of cultivation on lands adjoining
the railway. It will also, course, lead to an increase in the amount of crop destruction
due to railway-caused fires.
16-17: With these figures it is clear that it is better that the
railway should not be liable for the damage it causes, thus enabling it to operate
profitably. Of course, by altering the figures, - 17 - it could be shown that there are
other cases in which it would be desirable that the railway should be liable for the
damage it causes. It is enough for my purpose to show that, from an economic point of
view, a situation in which there is "uncompensated damage done to surrounding woods
by sparks from railway engines" is not necessarily undesirable.
17: The question at issue is not whether it is desirable to run an
additional train or a faster train or to install smoke-preventing devices; the question at
issue is whether it is desirable to have a system in which the railway has to compensate
those who suffer damage from the fires which it causes or one in which the railway does
not have to compensate them. When an economist is comparing alternative social
arrangements, the proper procedure is to compare the total social product yielded by these
different arrangements.
17: Pigou distinguishes between the case in which a person renders
services for which he receives no payment and the case in which a person renders
disservices and compensation is not given to the injured parties. Our main attention has,
of course, centered on this second case. It is therefore rather astonishing to find, as
was pointed out to me by Professor Francesco Forte, that the problem of the smoking
chimney-the "stock instance" or "classroom example" of the second
case-is used by Pigou as an example of the first case (services rendered without payment)
and is never mentioned, at any rate explicitly, in connection with the second case. Pigou
points out that factory owners who devote resources to preventing their chimneys from
smoking render services for which they receive no payment. The implication, in the light
of Pigou's discussion later in the chapter, is that a factory owner with a smoky chimney
should be given a bounty to induce him to install smoke-preventing devices. Most modern
economists would suggest that the owner of the factory with the smoky chimney should be
taxed. It seems a pity that economists (apart from Professor Forte) do not seem to have
noticed this feature of Pigou's treatment since a realization that the problem could be
tackled in either of these two ways would probably have led to an explicit recognition of
its reciprocal nature.
skip pp.18-21 to start of VIII--passage on rabbits
21: Economists who study problems of the firm habitually use an opportunity cost approach
and compare the receipts obtained from a given combination of factors with alternative
business arrangements. It would seem desirable to use a similar approach when dealing with
questions of economic policy and to compare the total product yielded by alternative
social arrangements.
22: A second feature of the usual treatment of the problems discussed
in this article is that the analysis proceeds in terms of a comparison between a state of
laissez faire and some kind of ideal world.... A better approach would seem to be to start
our analysis with a situation approximating that which actually exists, to examine the
effects of a proposed policy change, and to attempt to decide whether the new situation
would be, in total, better or worse than the original one. In this way, conclusions for
policy would have some relevance to the actual situation.
22: If factors of production are thought of as rights, it becomes
easier to understand that the right to do something which has a harmful effect (such as
the creation of smoke, noise, smells, etc.) is also a factor of production.
23: In devising and choosing between social arrangements we should have
regard for the total effect. This, above all, is the change in approach which I, am
advocating.
From LEA, omitted in abridged onlive version:
87: Sturges v. Bridgman (11 Ch. D. 852 (1879): Confectioner used two
mortars and pestles on Wigmore Street for 60 and 26 years. Doctor moved onto Wimpole
Street. Noise became a problem. Court ruled for doctor. But with easy transactions, the
ruling would not have affected use. (Barnes and Stout, 38-41)
88: Cooke v. Forbes (L.R. 5 Eq. 166 (1867-1868): weaving of cocoa-nut
fiber matting, immersed in bleaching liquids and hung out to dry. Fumes from sulphate of
ammonia manufacturer darkened and dulled the matting. Defendant recommended a different
bleaching agent. Sued for injunction and lost; invited to file for damages.
89: Bryant v. Lefever (4 C.P.D. 172 (1878-1879): (Barnes and Stout,
34-38) Defendant extended up a wall and blocked former path of plaintiff smoke. Court
ruled for defendant. Plaintiff created his own smoke.
91: The novelty of the situation is that the smoke nuisance was
suffered by the man who lit the fires and not by some third person.... The smoke nuisance
was caused both by the man who built the wall and by the man who lit the fires.
The judges' contention that it was the man who lit the fires who alone
caused the smoke nuisance is true only if we assume that the wall is the given factor....
The case would have been even more interesting if the smoke from the chimneys had injured
the timber.
91: If we are to discuss the problem in terms of causation, both
parties cause the damage. If we are to attain an optimum allocation of resources, it is
therefore desirable that both parties should take the harmful effect (the nuisance) into
account in deciding their course of action. It is one of the beauties of a smoothly
operating pricing system that, as has already been explained, the fall in the value of
production due to the harmful effect would be a cost for both parties.
92: Bass v. Gregory (25 Q.B.D. 481 (1890)) Plaintiffs owned a public
house, Jolly Anglers. Cellar had a vent into defendant's well, owner of some cottages and
a yard. Defendant blocked the well and got sued. Plaintiffs won by "doctrine of lost
grant." Irrelevant to economists.
98: Adams v. Ursell ([1913] 1 ch. 269) Fish and chips shop had to
relocate because odor was offensive to residents. "What has emerged [from Sturges v.
Bridgman] has been described as 'planning and zoning by the judiciary.'"
99: Smith v. New England Aircraft Co. (270 Mass. 511, 523 170 N.E. 385,
390 (1930) Freedom from liability for acts authorized. An extensive quote about the right
to impose nuisance without compensation for the public good.
Regan, Donald H. "The problem of social revisited." JLE 15 (1972): 427.
115: "For participants in n-person, variable-sum games we do
not...have any real satisfactory concept of rational behavior.... Each individual will
wish to see not only that the benefits of cooperation are achieved, but that he gets as
large a share of the benefits as possible. He will likely be led to threats of
non-cooperation as a device to increase his share. Clearly the threats will be ineffective
if they are not believed, and it is unlikely that threats will be generally be believed
unless they are occasionally carried out."
116-7: Even granting, then, that the allocation before the change of
legal rule was efficient, and that the allocation after the change must also be efficient,
there is no reason to assume they must be the same, if the change of legal rule effected a
redistribution of wealth, as there is every reason to suppose it did.
Demsetz, Harold. "When does the rule of liability matter?" JLS 1 (1972): 13.
123: [S]hort-run versus long-run considerations should have no bearing
on the Coase theorem, which is based on the proposition that an implicit cost (the forgone
payment from the farmer) is just as much a cost as is an explicit cost (the liability
damage), and this proposition surely must hold in the long run as well as in the short
run. One way of demonstrating this is by allowing the two activities to be merged under a
common owner.
124: Provides a numerical example
125-6: Market power can cause distortions
Kelman, Mark. "Consumption theory, production theory, and ideology in the coase
theorem." S. Cal L. Rev. 52 (1979): 52.
139: consumers fail to ignore sunk costs
141: Perhaps society learns what to value in part through the legal
system's descriptions of our protected spheres.
Simpson, A.W. "Coase v. Pigou Reexamined." JLS 25 (1996): 53
157: I am not convinced that it is necessary to Coase's economic
argument to do this violence to the everyday conception of causation or to reject the
evaluative distinction which everyday thought makes between harms and costs, but be that
as it may, his view certainly sets him apart from lawyers, who everywhere make use of
causal notions and do not treat harms and costs as equivalent.
157: What seems to me to be curious is that Coase, who on questions of
allocation and delimitation of rights has in mind private law, nowhere treats judicial
decisions in private law by the courts as a form of governmental intervention.
161: RR cases: Rex v. Pease; Vaughan v. Taff Vale Railway; Geddes v.
Proprietors of Bann Reservoir
163: The reason why a market transaction in the sense of a purchase and
sale of rights is usually not possible in such situations is that the parties are not
willing to place their rights in the market.
Coase, Ronald H. "Law and economics and A.W. Simpson." JLS 25 (1996): 25
173: The main lesson to be drawn from these studies is clear: The all
tend to suggest that the regulation is ineffective or that, when it has a noticeable
effect, on balance the effect is bad, so that consumers obtain a worse product or a
higher-priced product or both as a result of the regulation.