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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