The Problem of Social Cost

The Problem of Social Cost in the United States

I have said that the occupation of a neighbouring property by a cattle-

raiser would not cause the amount of production, or perhaps more exactly the
amount of planting, by the farmer to increase. In fact, 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.
This can be made clear by means of an arithmetical example. Assume initially
that the value of the crop obtained from cultivating a given tract of land is $12
and that the cost incurred in cultivating this tract of land is $10, the net gain
from cultivating the land being $2. I assume for purposes of simplicity that
the farmer owns the land. Now assume that the cattle-raiser starts operations
on the neighbouring property and that the value of the crops damaged is $I.
In this case $11 is obtained by the farmer from sale on the market and $1 is
obtained from the cattle-raiser for damage suffered and the net gain remains
$2. Now suppose that the cattle-raiser finds it profitable to increase the size of
his herd, even though the amount of damage rises to $3; which means that the
value of the additional meat production is greater than the additional costs,
including the additional $2 payment for damage. But the total payment for
damage is now $3. The net gain to the farmer from cultivating the land is
still $2. The cattle-raiser would be better off if the farmer would agree not to
cultivate his land for any payment less than $3. The farmer would be agreeable
to not cultivating the land for any payment greater than $2. There is clearly
room for a mutually satisfactory bargain which would lead to the abandonment
of cultivation. * But the same argument applies not only to the whole tract
cultivated by the fanner but also to any subdivision of it. Suppose, for example,
that the cattle have a well-defined route, say, to a brook or to a shady area. In
these circumstances, the amount of damage to the crop along the route may
well be great and if so, it could be that the farmer and the cattle-raiser would
find it profitable to make a bargain whereby the farmer would agree not to
cultivate this strip of land.
But this raises a further possibility. Suppose that there is such a well de-
fined route. Suppose further that the value of the crop that would be obtained
by cultivating this strip of land is $10 but that the cost of cultivation is $11.
In the absence of the cattle-raiser, the land would not be cultivated. However,
given the presence of the cattle-raiser, it could well be that if the strip was
cultivated, the whole crop would be destroyed by the cattle. In which case,
the cattle-raiser would be forced to pay $10 to the farmer. It is true that the
farmer would lose $1. But the cattle-raiser would lose $10. Clearly this is a
* The argument in the text has proceeded on the assumption that the alter-
native 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 dam-
age with the old crop would cause $I 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 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.
situation which is not likely to last indefinitely since neither party would want
this to happen. The aim of the farmer would be to induce the cattle-raiser to
make a payment in return for an agreement to leave this land uncultivated.
The farmer would not be able to obtain a payment greater than the cost of
fencing off this piece of land nor so high as to lead the cattle-raiser to abandon
the use of the neighbouring property. What payment would in fact be made
would depend on the shrewdness of the farmer and the cattle-raiser as bargain-
ers. But as the payment would not be so high as to cause the cattle-raiser to
abandon this location and as it would not vary with the size of the herd, such
an agreement would not affect the allocation of resources but would merely
alter the distribution of income and wealth as between the cattle-raiser and the
farmer.
I think it is clear that if the cattle-raiser is liable for damage caused and
the pricing system works smoothly, the reduction in the value of production
elsewhere will be taken into account in computing the additional cost involved
in increasing the size of the herd. This cost will be weighed against the value
of the additional meat production and, given perfect competition in the cattle
industry, the allocation of resources in cattle-raising will be optimal. 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
use of the land. In conditions of perfect competition, the amount which the
farmer would pay for the use of the land is equal to the difference between the
value of the total production when the factors are employed on this land and
the value of the additional product yielded in their next best use (which would
be what the farmer would have to pay for the factors). If damage exceeds
the amount the farmer would pay for the use of the land, the value of the
additional product of the factors employed elsewhere would exceed the value
of the total product in this use after damage is taken into account. It follows
that it would be desirable to abandon cultivation of the land and to release the
factors employed for production elsewhere. A procedure which merely provided
for payment for damage to the crop caused by the cattle but which did not
allow for the possibility of cultivation being discontinued would result in too
small an employment of factors of production in cattle-raising and too large an
employment of factors in cultivation of the crop. But given the possibility of
market transactions, a situation in which damage to crops exceeded the rent of
the land would not endure. Whether the cattle-raiser pays the farmer to leave
the land uncultivated or himself rents the land by paying the land-owner an
amount slightly greater than the farmer would pay (if the farmer was himself
renting the land), the final result would be the same and would maximise the
value of production. Even when the farmer is induced to plant crops which it
would not be profitable to cultivate for sale on the market, this will be a purely
short-term phenomenon and may be expected to lead to an agreement under
which the planting will cease. The cattle-raiser will remain in that location and
the marginal cost of meat production will be the same as before, thus having
no long-run effect on the allocation of resources.
IV. THE PRICING SYSTEM WITH NO LIABILITY FOR DAMAGE
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. As I showed in the previous case that the allocation of resources
was optimal, it will not be necessary to repeat this part of the argument.
I return to the case of the farmer and the cattle-raiser. The farmer would
suffer increased damage to his crop as the size of the herd increased. Suppose
that the size of the cattle-raiser’s herd is 3 steers (and that this is the size of the
herd that would be maintained if crop damage was not taken into account).
Then the farmer would be willing to pay up to $3 if the cattle-raiser would
reduce his herd to 2 steers, up to $5 if the herd were reduced to 1 steer and
would pay up to $6 if cattle-raising was abandoned. The cattle-raiser would
therefore receive 53 from the farmer if he kept 2 steers instead of 3. 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 2 to
3 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. The size of the herd will be the same whether the cattle-raiser is liable for
damage caused to the crop or not.

Posted

in

, ,

by

Tags:

Comments

Leave a Reply

Your email address will not be published. Required fields are marked *