Suppose that Jones stumbles upon the idea of pickling cucumbers. It has never before been done. Jones’s pickle company is spectacularly successful. He soon invests $10 billion in a firm – land, factories, delivery trucks, worker training, brand-name development, the whole shebang. At first Jones sees his investment pay handsome returns. But Jones produces only one size pickle (large), one cut (whole), and one flavor (dill). A few years later Smith decides to try his luck at selling pickles. Smith invests a mere $6 billion and produces more varieties, cuts, and flavors. Smith’s Pickle Co. is so successful that Jones’s firm goes bankrupt. All but the scrap value of Jones’s firm is destroyed by Smith’s competitive entry into the pickle industry.
Is the destruction of the value of Jones’s firm a social cost caused by Smith’s entry into pickling? Smith, we can be sure, did not – when he decided to enter the pickle industry – take account of (“internalize”) the prospective destruction of the capital value of Jones’s firm. Is Smith’s entry into the pickle industry therefore socially wasteful? Would your answer to this question be different if everything remained as described above except that the only difference between Smith’s pickles and Jones’s pickles is that Smith offers, not one or many, but two and only two flavors of pickles: dill and sweet?