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7 Rev. L & Econ. 1 (2011)

handle is hein.journals/rvleco7 and id is 1 raw text is: The Problem of Social Cost: What Problem? A Critique of the Reasoning of A.C. Pigou and R.H. Coase HAROLD DEMSETZ University of California, Los Angeles This essay discusses and refutes allegations by A.C. Pigou and R.H. Coase that a competitive, private-ownership economic system that conforms to the neoclassical modelfails to allocate resources efficiently. The essay then suggests a source of inefficiency that differs from and is much more limited in application than are those offered by Pgou and Coase; and the suggested source, moreover, is compatible with the neoclassical model. 1. INTRODUCTION The 18th century debate between mercantilists and Scottish philosophers came to an important juncture in 1776 when Adam Smith published his remarkable work The Wealth of Nations. Smith's contributions to the emerging new discipline of economics were multifaceted and far-reaching, but most relevant to this debate was his claim that a competitive, private-ownership economy in which persons act freely to serve their own interests could, and would, serve the public's interest also. This was a rejoinder to the view held by mercantilists, who saw the well-being of a nation as dependent on its stocks of gold and other precious metals, and who called for the State to control trade in ways that enhanced these stocks. Smith's work set before future economist-philosophers the task of proving or disproving the generality of this claim. Essential to this task was the development of a model of a decentralized, private-ownership economic system, one in which individuals freely act on behalf of their own personal interests, have no control over each other's actions, and inform their decisions by way of market-determined prices. Mainline economists writing during the neoclassical period of economics completed this task (and others) early in the 20th century. The core of their modeling effort became known as the perfect competition model, a label that seems misleading to me. The model really says little about competitive activities except insofar as entry and exit into a market is thought of as a competitive activity; that is, the model says

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