By Ronald H. Coase

“But in choosing among social arrangements within the context of which individual decisions are made, we have to bear in mind that a change in the existing system which will lead to an improvement in some decisions may well lead to a worsening of others.”

The Problem of Social Costs is a paper that focuses on the actions of business firms that have harmful effects on others (know as negative externalities.)  Coase points out that when dealing with externalities it is important to understand what the consequences are of stopping the particular externality from occurring.

Coase uses an example of a doctor suing a confectioner (candy-maker) because the confectioner’s loud machinery is disturbing the doctor’s work.  Coase poses a critical question: should the confectioner be able to harm the doctor by continuing to run his machinery without compensating him for the disturbance, or should the doctor be allowed to harm the confectioner by forcing the confectioner to stop (or adjust) his production to accommodate the doctor’s needs.  In other words, Coase is showing that avoiding harming the doctor imposes harm on the confectioner.  

The point Coase is making is that externalities are reciprocal in nature; so our task is to avoid the more serious harm.  The solution is unclear unless we know the value of what is obtained and the value of what is sacrificed to obtain it.

Coase goes on to state that when people are prevented from sleeping at night because of the noise from jet planes, or are unable to think because of the vibrations from passing trains, or find it difficult to breath because of the odor from a sewage plant, they start to advocate the need for government regulation over private enterprise.  However, he claims that these people misunderstand the nature of the situation: the activities they would like to regulate could be socially justified.  It comes down to weighing the gains from eliminating these harmful effects with the gains that come from allowing them to continue.

The Problem of Social Costs was monumental in changing how economists think about externalities, and thus how the problem of negative externalities can best be solved.