ABSTRACT
The problem of social costs came to light chiefly associated with the idea of negative externalities in Arthur Pigou's Economics of Welfare, first published in 1920 (Pigou 1932). In Pigou's understanding a social cost was the outcome of accidentally rendering disservices to other persons besides those directly involved in a transaction. In the presence of negative externalities the social cost of economic activity is not covered by the private cost; in other words, market prices do not reflect real costs, which may lead to over-consumption of a product or resource. In these circumstances the free play of self-interest may induce an inefficient distribution of resources, and Pigou's aim was precisely to find a way for the state to improve upon markets’ natural tendencies (Coase 1960), which means internalizing social costs.
