On Divergences between Social Cost and Private Cost

The notion that the resource-allocation effects of divergences between marginal social and private costs can be dealt with by imposing a tax or granting a subsidy equal to the difference now seems too simple a notion. Three recent articles have shown us this. First came Professor Coase’s “The Problem of Social Cost”, then Davis and Whinston’s “Externalities, Welfare and the Theory of Games” appeared, and, finally, Buchanan and Stubblebine have published their paper “Externality”.1 These articles have an aggregate length of eighty pages and are by no means easy to read. The following attempt to synthesise and summarise the main ideas may therefore be useful. It is couched in terms of external diseconomies, i.e. an excess of social over private costs, and the reader is left to invert the analysis himself should he be interested in external economies.