Question

In his 1960 article, ”The Problem of Social Cost,” Ronald Coase uses an example of a rancher and a wheat farmer. The problem comes from the rancher’s cows crossing over onto the farmer’s fields and trampling his crop. For the next problems assume the damage to the farmer’s crops is $1,000 a year and the cost of putting up/maintaining a fence is $1,500 a year.

1. The farmer takes the rancher to court and the judge decides putting up a fence is the farmer’s responsibility. What is the nature of the externality in this problem?

A. the rancher is putting a $1000 cost on the farmer that he is not internalizing.

B. the farmer is putting a $1000 benefit on the rancher that is not internalized.

C. the rancher is putting a$1500 cost on the farmer that he is not internalizing.

D. there is no externality present because rights are defined.

2. After the court decision, will the farmer build a fence?

A. Yes

B. No

C. The rancher will build the fence

D. There is not enough information to say

3.. Suppose the judge ruled that the rancher is responsible for keeping the cows off the farmer’s land. Will the rancher build the fence?

A. Yes, he is required by law.

B. Yes, because it is more efficient to put the fence up.

C. No, he would pay the farmer $1,000 to compensate him for the damages to his crops.

D. There is not enough information to say.

Answer 1

1> A. the rancher is putting a $1000 cost on the farmer that he is not internalizing.

Because of the rancher, the farmer is incurring a loss of $1000, clearly he does not consider it as his cost, thus he is not internalizing it.

2> B. No

Since building the fence makes no monetary sense, the farmer will not make the fence

3> C. No, he would pay the farmer $1,000 to compensate him for the damages to his crops.

Since the damage caused by this is $1000 which is less than the money required to make the fence, thus he should rather compensate.